Case 3. Will the pizza taste better? Popa\'s Pizza is considering replacing an e

Question

Case 3. Will the pizza taste better? Popa's Pizza is considering replacing an existing oven with a new, more sophisticated oven. The old oven was purchased three years ago at a cost of $40,000, and this amount was being depreciated using a five-year straight-line depreciation to zero. The oven has five years of usable life remaining. The new oven being considered costs $50,000, requires $2,000 in installation costs, and would be depreciated using 5-year MACRS depreciation. The new oven would also require an increase in net working capital of $700 when it is installed. The old oven can currently be sold for $16,000 with no removal or cleanup costs. The firm pays taxes at a rate of 40 percent. The revenues and expenses (excluding depreciation) associated with the new and old oven for the next 5 ears are given in the following table New Oven Old Oven Year Revenue Revenue Expenses (excluding depreciation $120,000 $125,000 $130,000 $135,000 $140,000 At the end of this 5-year useful life, the new oven can be sold for $20,000. If the old over were to be kept, it could be sold for $5,000 at end of this 5-year period 1. Calculate the initial cash outflow associated with the replacement of the Expenses (excluding depreciation $110,000 $115,000 $120,000 $125,000 $130,000 $250,000 $260,000 $270,000 $280,000 $290,000 $220,000 $230,000 $240,000 $250,000 $260,000 2 4 old oven with the new one

Explanation / Answer

1) Inital cashoutflow

Price of new oven - market value of old oven

= 50,000 + 2000 + 700 - 16000

= $ 36,700

2)

3)

Terminal cash flow would be 150,000 operating cash flow + 5000 salvage value + 700 net working capital

= $ 155,700

4)

New OLD Incremental cash flow Year rev exp cashflow rev exp cashflow 1          250,000          120,000          130,000    220,000    110,000    110,000                                 20,000 2          260,000          125,000          135,000    230,000    115,000    115,000                                 20,000 3          270,000          130,000          140,000    240,000    120,000    120,000                                 20,000 4          280,000          135,000          145,000    250,000    125,000    125,000                                 20,000 5          290,000          140,000          150,000    260,000    130,000    130,000                                 20,000

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