Question

Pappy's Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy's paid $130,000 for a narketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $845,000 per year. The fixed osts associated with this will be $208,000 per year, and variable costs will amount to 20 percent of sales. The equipment necessary or production of the Potato Pet will cost $870,000 and will be depreciated in a straight-line manner for the four years of the product fe (as with all fads, it is felt the sales will end quickly). This is the only initial cost for the production. Pappy's has a tax rate of 22 bercent and a required retum of 14 percent.

a. Calculate the payback period for this project. Note: Do not round intermediate calculations and round your answer to 2 decimal places, e.g. 32.16 .
b. Calculate the NPV for this project. Note: Do not round intermediate calculations and round your answer to 2 decimal places, e.g. 32.16 .
c. Caiculate the IRR for this project. Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16 .

Answer 1

The payback period for Pappy's new Potato Pet project is approximately 2.14 years based on the provided costs and sales estimates. The NPV is calculated by discounting the net cash flows at the required return rate of 14% and accounting for taxes. The IRR is the discount rate at which the NPV equals zero and usually requires computational tools to determine.

Step-by-step explanation:

To calculate the payback period for Pappy's Potato's new product, the Potato Pet, we first determine the net cash flow per year by subtracting both the fixed and variable costs from the annual sales. The variable cost is 20 percent of sales, so for $845,000 in sales, the variable cost is $169,000. Subtracting the fixed costs of $208,000 and variable costs from the annual sales gives a net cash flow of $468,000. The initial investment is $870,000 (equipment cost) plus $130,000 (marketing survey), totaling $1,000,000. The payback period is the initial investment divided by the net annual cash flow, which is approximately 2.14 years.

To calculate the Net Present Value (NPV), we discount the net cash flows over the product's life at the required return rate of 14 percent and then subtract the initial investment. The after-tax cash flow would be considered as well by accounting for the tax rate of 22 percent applied to the project's earnings before taxes.

Determining the Internal Rate of Return (IRR) involves finding the discount rate that makes the NPV of all cash flows equal to zero. This typically requires using financial software or a program since the calculation is iterative.