Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy’s paid $120,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $575,000 per year. The fixed costs associated with this will be $179,000 per year, and variable costs will amount to 20 percent of sales. The equipment necessary for production of the Potato Pet will cost $620,000 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 is in a 40 percent tax bracket and has a required return of 13 percent.
What is the initial (t=0) cash outflows?
What is the operating cash inflows at t=1?
What is the total cash flows (operating cash flows plus terminal cash flows) at t=4?
Compute the NPV and IRR of the project. Should this new project be accepted?