Question

A college friend of mine just filed for a patent for a new product – the “bowling buddy” bowlers’ training aid. The bowling buddy sells for $55 and the variable cost per unit is $26. They rent production space for $25,000 annually. The initial investment is $250,000 and the project life is 5 years. Assume appropriate discount rate is 10% and ignore taxes. Assuming my friend can sell 4,000 bowling buddies per year, what is the IRR of the project?

B)  Assuming my friend can sell 3,000 bowling buddies per year, what is the discounted payback period of the project?

Answer 1

Part A:

Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
No of units		4,000	4,000	4,000	4,000	4,000
Selling price		$                55	$               55	$                55	$                55	$               55
Operating cost		$                26	$               26	$                26	$                26	$               26
Sale		$       220,000	$      220,000	$       220,000	$       220,000	$      220,000
Less: Operating Cost		$       104,000	$      104,000	$       104,000	$       104,000	$      104,000
Contribution		$       116,000	$      116,000	$       116,000	$       116,000	$      116,000
Less: Marketting cost		$         25,000	$        25,000	$         25,000	$         25,000	$        25,000
Cash flow		$         91,000	$        91,000	$         91,000	$         91,000	$        91,000
Calculation of IRR
			23.00%		24.00%
Year		Total cash flow	PV factor @ 23%	Present values	PV factor @ 24%	Present values
0		$     (250,000)	1.000	$     (250,000)	1.000	$     (250,000)
1		$         91,000	0.813	$         73,984	0.806	$        73,387
2		$         91,000	0.661	$         60,149	0.650	$        59,183
3		$         91,000	0.537	$         48,902	0.524	$        47,728
4		$         91,000	0.437	$         39,758	0.423	$        38,491
5		$         91,000	0.355	$         32,323	0.341	$        31,041
				$           5,116		$            (170)
		IRR	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
		IRR	'=23%+ (24%-23%)*(5116.04/(5116.04-(-170.01)
			23.97%

Part B:

Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
No of units		3,000	3,000	3,000	3,000	3,000
Selling price		$                55	$               55	$                55	$                55	$               55
Operating cost		$                26	$               26	$                26	$                26	$               26
Sale		$       165,000	$      165,000	$       165,000	$       165,000	$      165,000
Less: Operating Cost		$         78,000	$        78,000	$         78,000	$         78,000	$        78,000
Contribution		$         87,000	$        87,000	$         87,000	$         87,000	$        87,000
Less: Marketting cost		$         25,000	$        25,000	$         25,000	$         25,000	$        25,000
Cash flow		$         62,000	$        62,000	$         62,000	$         62,000	$        62,000
Calculation of Discounted payback period
Year					Annual Cash flow	PV factor @ 10%	Present values	Cumulative PV
0					$     (250,000)	1.000	$     (250,000)	$ (250,000)
1					$         91,000	0.909	$         82,727	$ (167,273)
2					$         91,000	0.826	$         75,207	$   (92,066)
3					$         91,000	0.751	$         68,370	$   (23,696)
4					$         91,000	0.683	$         62,154	$    38,458
5					$         91,000	0.621	$         56,504	$    94,962
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