Pie Guy Pizza Parlor is considering the purchase of a large oven and related equ
ID: 2474142 • Letter: P
Question
Pie Guy Pizza Parlor is considering the purchase of a large oven and related equipment for mixing and baking "crazy bread." The oven and equipment would cost $146,000 delivered and installed. It would be usable for about 15 years, after which it would have a 10% scrap value. The following additional information is available:
The owner of the pizza parlor estimates that purchase of the oven and equipment would allow the pizza parlor to bake and sell 75,000 loaves of crazy bread each year. The bread sells for $1.30 per loaf.
The cost of the ingredients in a loaf of bread is 40% of the selling price. The owner estimates that other costs each year associated with the bread would be as follows: salaries, $11,000; utilities, $7,000; and insurance, $4,000.
The pizza parlor uses straight-line depreciation on all assets, deducting salvage value from original cost.
Prepare a contribution format income statement showing the net operating income each year from production and sale of the crazy bread.
Compute the simple rate of return for the new oven and equipment. (Round percentage answer to 1 decimal place. i.e. 0.123 should be considered as 12.3%.)
If a simple rate of return above 11% is acceptable to the owner, will he purchase the oven and equipment?
Compute the payback period on the oven and equipment.
If the owner purchases any equipment with less than a six-year payback, will he purchase this equipment?
Pie Guy Pizza Parlor is considering the purchase of a large oven and related equipment for mixing and baking "crazy bread." The oven and equipment would cost $146,000 delivered and installed. It would be usable for about 15 years, after which it would have a 10% scrap value. The following additional information is available:
Explanation / Answer
Solution:
1) Preparation of contribution format income statement showing the net operating income:
Working Note:
Depreciation = [146,000 - (146,000 * 10%)]/ 15 = 8,760
2) a) Calculation of simple rate of return for the new oven and equipment:
Simple rate of return = Annual incremental net operating income/ Initial investment
= 27,740/ 146,000
= 0.19
= 19%
2) b) If a simple rate of return above 11% is acceptable to the owner:
Yes, the oven and equipment would be purchased since their return exceeds 11% requirement.
3) a) Calculation of payback period on the oven and equipment:
Payback period = Initial investment/ Net annual cash flow
= 146,000/ 36,500
= 4 Years
Net annual cash flow = 27,740 (net operating income) + 8,760 (depreciation) = 36,500
3) b) If the owner purchases any equipment with less than a six-year payback:
Yes, the oven and equipment would be purchased. The payback period is less than the 6-year period.
Sales revenue (75,000 * 1.30) 97,500 Less cost of ingredients (97,500 * 40%) 39,000 Contribution margin 58,500 Less operating expenses Utilities 7,000 Salaries 11,000 Insurance 4,000 Depreciation 8,760 Total operating expenses 30,760 Net operating income 27,740