1. Your boss asks you to evaluate the purchase of a new battery-operated toaster

Question

1. Your boss asks you to evaluate the purchase of a new battery-operated toaster for his restaurant chain. The toaster [ BT ] costs $80 per unit, and has an estimated useful life of six years. The toaster requires batteries once a week yielding an annual operating cost of $120 per year; salvage value of both toaster and batteries is $9. The alternative is to purchase an electric toaster [ ET ] that will last seven years and costs $160. The estimated annual electric bill for this toaster is $100, and it has an expected salvage value of $11. If the company anticipates purchase of 10000 toasters for eternity, which model should you recommend? (Assume a tax rate of 35% and a WACC of 9%.)

2. If toaster BT's annual battery costs increase by $3 and ET's annual electric costs decrease by $3 which toaster

would you recommend now?

3. If toaster BT's annual battery costs decrease by $7 and ET's toaster cost decrease by $7 which toaster would you

recommend now?

Explanation / Answer

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1 Calculation of PV of outflows BT ET Annual cash outflows 120 100 useful life 6 7 Annuity Factor 4.4859 5.033 PV Of cash flows 538.308 503.3 Add: Initial Investment 80 160 Less: Post Tax salvage value 5.366406 6.017377 PV of cash outflows(net) 623.6744 669.3174 BT has lower Pv of outflows it should be purchased 2 Calculation of PV of outflows BT ET Annual cash outflows 123 97 useful life 6 7 Annuity Factor 4.4859 5.033 PV Of cash flows 551.7657 488.201 Add: Initial Investment 80 160 Less: Post Tax salvage value 5.366406 6.017377 PV of cash outflows(net) 637.1321 654.2184 BT has lower Pv of outflows it should be purchased 3 Calculation of PV of outflows BT ET Annual cash outflows 113 100 useful life 6 7 Annuity Factor 4.4859 5.033 PV Of cash flows 506.9067 503.3 Add: Initial Investment 80 153 Less: Post Tax salvage value 5.366406 6.017377 PV of cash outflows(net) 592.2731 662.3174 BT has lower Pv of outflows it should be purchased

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