The Burning Belly Taco Stand is considering buying some new special ovens. Each

Question

The Burning Belly Taco Stand is considering buying some new special ovens. Each oven will cost $1,000, and will last for 2 years before it wears out. The ovens will be used to make the Taco Stands famous "Burning Ring of Fire" tacos, and will generate a value of marginal product of $600 for the first oven, $570 for the second oven, and $530 for the third oven.(Assume all revenues are earned at the end of the year.) If the interest rate is 10 percent, how many ovens will the Burning Belly Taco Stand buy? (hint: calculate the present value of the VMP of the first, second and third oven, and compared that with the purchase price of the oven)

Explanation / Answer

The Burning Belly Taco Stand will buy only one oven.

We are given that each oven cost $1000 and last for 2 years. Rate of interest is 10%.

VMP of first oven is $600.

So the present value of VMP of first oven = [600/(1+ 10/100)] + [600/(1+10/100)2]

= [600/1.1]+ [600/1.12]

= 545.45 + 495.867 = $1041.317

VMP of second oven = $570

So, the present value of VMP of second oven = [570/1.1] + [570/1.12]

= 518.18 + 471.07 = $989.25

VMP of third oven= $530

So, the present value of VMP of third oven = [530/1.1] + [530/1.12]

= 481.818 + 438.016 = $919.834

Since the present value of VMP of only first oven exceeds it cost which is $1000, so Burning Belly Taco Stand will buy only one oven.

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