Pete’s Pizza is planning to purchase a new type of oven that cooks pizza much fa
ID: 2475557 • Letter: P
Question
Pete’s Pizza is planning to purchase a new type of oven that cooks pizza much faster than the conventional oven now used. The new oven is es- timated to cost $20,000 (use straight-line depreciation) and will have a five-year life, after which it will be traded in for $4,000. Pete has cal- culated that the new oven will allow him to increase his sales by $30,000 a year. His food cost is 30 percent, labor cost is 40 percent, and other costs are 10 percent of sales revenue. Tax rate is 40 percent. For any new investment, Pete wants a minimum 12 percent return. Use IRR to help him decide if he should purchase the new oven.
Explanation / Answer
Cash out flow Calculation:
Particulars ::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::Amount
Sales Revenue ::::::::::::::::::::::::::::::::::$30,000 *5=$150,000
Less:
Food cost ::::::::$9,000 (30,000 *30100=$9,000) *5 years=$45,000
labor cost :::::::::$12,000(30,000 *40/100=$12,000)*5 years=$60,000
Other Cost::::::::$3,000($30,000*10/100=$3,000)*5years=$15,000
Depreciation::::::$3,200(20,000 -4,000 /5years=4,000)*5=$16,000
_____________________________________________________
Profit before tax:::::::::::::::::::::::::::::::::::::::::::::::::::$14,000
Less
Tax:::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::$5,600(14,000 *40/100=$5,600)
__________________________________
Profit after tax =$8,400
_____________________________________
IRR= Initial Investment /CFAT
=20,000 /$8,400
=2.38
By present value annuity value founded for 2.38 in 12%(nearest value is 2.4018) in 3 year
Owner seeking 12% return, IRR shown 12% so, Pete can purchase the new owen.
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