Pappy's Potato has come up with a new product, the Potato Pet (they are freeze-dried to last...

Question:

Pappy's Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy's paid $134,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of$589,000 per year. The fixed costs associated with this will be $193,000 per year, and variable costs will amount to 18 percent of sales. The equipment necessary for production of the Potato Pet will cost$648,000 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 35 percent tax bracket and has a required return of 15 percent.

Calculate the time 0 cash flow for this project.

Calculate the OCF for this project

Operating Cash Flow:

Operating Cash Flow often called "OCF" is the amount of cash flow which is generated by the regular business operations of the company. It is the amount which flows inwards to the company.

Calculate the time 0 cash flow for this project.

The time 0 cash flow refers to the cash outflow of the company which is $648,000 as stated in the question. The amount of$648,000 is invested in year 0 as the cost of the equipment necessary for production.

Calculate the OCF for this project

 Particular Amounts Sales $589,000 Variable Cost ($106,020) Contribution $482,980 Fixed Cost ($193,000) Depreciation ($162,000) EBT$127,980 Tax ($44,793) EAT$83,187 Add: Depreciation $162,000 OCF$245,187

Working Note:

{eq}\begin{align*} {\rm{Variable}}\,{\rm{Cost}} &= \$589,000 \times 18\% \\ &= \$ 106,020\\ {\rm{Depreciation}} &= \dfrac{{\$648,000}}{4}\\ &= \$ 162,000\\ {\rm{Tax}} &= \$127,980 \times 35\% \\ &= \$ 44,793 \end{align*} {/eq}