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Greencastle Pizzeria is considering expanding operations by establishing a delivery business. This will require the purchase...

Greencastle Pizzeria is considering expanding operations by establishing a delivery business. This will require the purchase of an oven that will cost $60,000, including installation. The oven is expected to last five years, have a $6,000 residual value, and will be depreciated using the straight-line method. Cash flows associated with the delivery business are as follows:

Item

Year 1

Year 2

Year 3

Year 4

Year 5

Revenue

 $78,000 $79,560 $93,884 $105,600 $114,290

Ingredients

 (30,120 ) (33,120 ) (36,474 ) (40,133 ) (44,036 )

Salary

 (29,880 ) (32,280 ) (34,680 ) (37,080 ) (39,360 )

Additional misc.

 (2,520 ) (2,760 ) (3,000 ) (3,240 ) (3,360 )

Residual value

 6,000


In addition to the above, there are tax consequences related to the new business, and the company’s tax rate is 20 percent.

Click here to view factor tables

Calculate the internal rate of return for the delivery business. (Hint: Try a range of rates between 14 percent and 16 percent.) (Round present value factor calculations to 4 decimal places, e.g. 1.2151 and final answer to 0 decimal places, e.g. 18%.)

The internal rate of return enter the internal rate of return in percentages rounded to 0 decimal places  %


Should Greencastle Pizzeria invest in the delivery business if the required rate of return is 10 percent?

Greencastle Pizzeria select an option                                                          shouldshould not invest in the delivery business.

Solutions

Expert Solution

   ANSWERS

ITEMS YEAR 1 $ YEAR 2 $ YEAR 3 $ YEAR 4 $ YEAR 5 $
Revenue 78000 79560 93884 105600 114290
Ingredients (30120) (33120) (36474) (40,133) (44036)
salary (29880) (32280) (34680) (37080) (39360)
additional misc. (2520) (2760) (3000) (3240) (3360)
depreciation (10800) (10800) (10800) (10800) (10800)
Profit 4680 600 8930 14347 16734
Tax @20% (936) (120) (1786) (2869) (3347)
Profit after tax 3744 480 7144 11478 13387
Add back depreciation 10800 10800 10800 10800 10800
Scrap 6000

Profit before depreciation

but after tax

 14544 11280 17944 22278 18187

NOTE: COMPUTATION OF DEPRECIATION

ANNUAL DEPRECIATION = 60000-6000 =10800

2

  

YEAR CASH FLOW PV FACTOR @ 14% PRESENT VALUE   PV FACTOR @16% PRESENT VALUE
1 14544 0.8771 12757 0.8620 12537
2 11280 0.7694 8679 0.7431 8382
3 17944 0.6749 12110 0.6406 11495
4 22278 0.5920 13189 0.5522 12302
5 18187 0.5193 9445 0.4761 8659
56180 53375
(60000) (60000)
NPV (3820) (6625)

IRR = LOWER RATE + NPV AT LOWER RATE *(HIGHER RATE -LOWER RATE )

   NPV AT HIGHER RATE -NPV AT LOWER RATE

IRR = 14 + (3820) *( 16-14)

(6625)- (3820)

= 11.276 OR 11%

So IRR is 11%

answer of second part of the question

since the rate of return is 10% compared to the above 11% .The rate of return is 11% , I will suggest that Greencastle Pizzeria should not go for delivery bussiness because its rate of return is low . Its better to continue the existing business .

ekkarill92 answered 2 years ago
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