Question

Use the following information to answer the next 3 questions.

Pappy’s Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). It is expected 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 $920,000 and will be depreciated to zero 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). The equipment will require an increase in working capital (spare parts inventory) of $7,500 at the beginning. Pappy’s is in a 35 percent tax bracket and has a required return of 14 percent.

[Use Excel to answer the questions. Without Excel worksheet, no credit will be earned.]

1. What is the NPV and IRR of the project? Is the project acceptable?

2. Do the following scenario analyses:

What if the sales level is 50% higher than the current estimate? Compute the NPV and IRR of the project.

What if the sales level is 75% higher than the current estimate? Compute the NPV and IRR of the project.

What if the sales level is 50% lower than the current estimate? Compute the NPV and IRR of the project.

What if the sales level is 75% lower than the current estimate? Compute the NPV and IRR of the project.

3. What is the breakeven price of the equipment? (What price of the equipment will make the NPV equal zero?)

Answer 1

Based on the NPV and IRR, they shouldn't go for the project as they both are negative.

Breakeven equipment price = $ 688925.59