Barbarian Pizza is analyzing the prospect of purchasing an additional fire brick

Question

Barbarian Pizza is analyzing the prospect of purchasing an additional fire brick oven. The oven costs $200,000 and would be depreciated (straight-line to a salvage value of $120,000 in 10 years. The extra oven would increase annual revenues by $120,000 and annual operating expenses by $90,000. Barbarian’s marginal tax rate is 25%. This should all be done in excel.
a.         What would be the initial, operating, and terminal cash flows generated by the new                          oven?
b.         What is the payback period for the additional oven?
c.         Barbarian Pizza’s RRR is 12%. What is the NPV of the additional oven?
d.         What is the IRR of the additional oven?

Explanation / Answer

Solution:

Year 0 1 2 3 4 5 6 7 8 9 10 Initial Cashflow 200000 0 0 0 0 0 0 0 0 0 0 Increase in Revenue 0 120000 120000 120000 120000 120000 120000 120000 120000 120000 120000 Less: Operating Costs 0 90000 90000 90000 90000 90000 90000 90000 90000 90000 90000 Less: Depreciation 0 8000 8000 8000 8000 8000 8000 8000 8000 8000 8000 Total Revenue 22000 22000 22000 22000 22000 22000 22000 22000 22000 22000 Tax Expense ( 25 % ) 5500 5500 5500 5500 5500 5500 5500 5500 5500 5500 After Tax Revenues 16500 16500 16500 16500 16500 16500 16500 16500 16500 16500 Add: Depreciation 24500 24500 24500 24500 24500 24500 24500 24500 24500 24500 Add: Terminal Cashflow 120000 Cashflows 24500 24500 24500 24500 24500 24500 24500 24500 24500 144500 Present Value of 1 $ @ 12 % 0.892857 0.7971939 0.71178 0.635518 0.567427 0.506631 0.452349 0.403883 0.36061 0.321973 Present value of Cash Inflows 21875 19531.25 17438.62 15570.19 13901.96 12412.46 11082.56 9895.139 8834.946 46525.13 Total Present Value of Cashflows 177067.2526 Payback period = Initial Investment / Cashflow per period 8.163265 or 8 years NPV Present value of Cash Inflows - Initial Cashflow = 177067 - 200000 = 22,933

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