Question

calculate payback period and IRR

Pappy's Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy's paid $165,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $880,000 per year. The fixed costs associated with this will be $222,000 per year, and variable costs will amount to 18 percent of sales. The equipment necessary for production of the Potato Pet will cost $940,000 and will be depreciated in a straight-line manner for the four years of the product life (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 24 percent and a required return of 13 percent. N 70 Calculate the Time O cash flow for this project. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Answer 1

Time line		0
Cost of new machine		-940000
=Initial Investment outlay		-940000

Time line		0	1	2	3	4
Cost of new machine		-940000
=Initial Investment outlay		-940000
							100.00%
Sales			880000	880000	880000	880000
Profits	Sales-variable cost		721600	721600	721600	721600
Fixed cost			-222000	-222000	-222000	-222000
-Depreciation	Cost of equipment/no. of years		-235000	-235000	-235000	-235000	0	=Salvage Value
=Pretax cash flows			264600	264600	264600	264600
-taxes	=(Pretax cash flows)*(1-tax)		201096	201096	201096	201096
+Depreciation			235000	235000	235000	235000
=after tax operating cash flow			436096.00	436096.00	436096	436096
+Tax shield on salvage book value	=Salvage value * tax rate					0
=Terminal year after tax cash flows						0
Total Cash flow for the period		-940000	436096.00	436096.00	436096.000	436096

Project
Year	Cash flow stream	Cumulative cash flow
0	-940000	-940000
1	436096	-503904
2	436096	-67808
3	436096	368288
4	436096	804384
Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 2 and 3
therefore by interpolation payback period = 2 + (0-(-67808))/(368288-(-67808))
2.16 Years
Project
IRR is the rate at which NPV =0
IRR	0.302974796
Year	0	1	2	3	4
Cash flow stream	-940000	436096	436096	436096	436096
Discounting factor	1	1.302975	1.697743	2.212117	2.8823324
Discounted cash flows project	-94000000.00%	334692.6	256868	197139.7	151299.69
NPV = Sum of discounted cash flows
NPV Project =	2.19402E-05
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	30.30%