Question

. Grotto’s is considering purchasing a new pizza oven and the choices are: Middleby Marshall vs Blodgett. The following are the costs and incremental cash flows from each in 3 years:   

Years                                 Middleby Marshall                              Blodgett

0                                        -$15,000                                              -$19,000

1                                        $10,400                                              $12,700

2                                        $ 5,900                                               $ 6,100

3                                        $ 2,100                                               $ 5,300

      a) If the company’s required payback is 2 years, which of these two ovens should be

      accepted?

      b) Grotto’s cost of capital is 15%. Based on NPV which oven should be bought?

Answer 1

Years	Discount factor 15%	Middleby Marshall (A)	PV of A	Blodgett (B)	PV of B
0 ( Cash outflow)	1	$15,000	15,000	$19,000	19,000
1	0.870	$10,400	9,048	$12,700	11,049
2	0.756	$ 5,900	4,460.4	$ 6,100	4,611.6
3	0.658	$ 2,100	1,381.8	$ 5,300	3,487.4

(a) Payback Period = Completed Years + Remaining Amount / Available Amount

10,400 recovered in Year 1 ; Remaining Amount  = 15,000 -10,400 = 4,600 ; Available Amount = 5,900

Completed Year = 1 ;

payback period for Middleby Marshall = 1 + 4,600/ 5,900 = 1.779 years = 1.78 years

12,700 recovered in Year 1 ; Remaining Amount = 19,000 - 12,700 = 6,300 ; Available Amount = 6,100

Completed Year = 1 ;

payback period for Blodgett= 1 + 6,300 / 6,100 = 2.03 years

Middleby Marshall should be accepted

(b) Net Present Value = Present Value of Cash Inflow - Present value of cash outflow

NPV for Middleby Marshall = 9048 + 4460.4+ 1381.8 - 15000 = -109.8

NPV for Blodgett = 11049 + 4611.6 + 3487.4 - 19000 = 148

Since Blodgett has a positive NPV of 148, This should be accepted

( if you have any query, please comment, I will revert back to you in the comment)