Question

Lugano’s 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 $170,000 delivered and installed. It would be usable for about 10 years, after which it would have a 10% scrap value. The following additional information is available: a. Mr. Lugano estimates that purchase of the oven and equipment would allow the pizza parlor to bake and sell 60,000 loaves of crazy bread each year. The bread sells for $1.50 per loaf. b. The cost of the ingredients in a loaf of bread is 30% of the selling price. Mr. Lugano estimates that other costs each year associated with the bread would be as follows: salaries, $18,000; utilities, $8,000; and insurance, $3,000. c. The pizza parlor uses straight-line depreciation on all assets, deducting salvage value from original cost. (Ignore income taxes.) Required: 1. Prepare a contribution format income statement showing the net operating income each year from production and sale of the crazy bread. (Input all amounts as positive values.) 2a. Compute the simple rate of return for the new oven and equipment. (Round your answer to 1 decimal place.) 2b. If a simple rate of return above 10% is acceptable to Mr. Lugano, will he purchase the oven and equipment? 3a. Compute the payback period on the oven and equipment. 3b. If Mr. Lugano purchases any equipment with less than a seven year payback, will he purchase this equipment?

Answer 1

1) Contribution format Income Statement:
	Per unit	Amount$
Sales (60000)	1.5	90000
Less:Variable costs	0.45	27000
Contibution	1.05	63000
Less: Fixed Costs:
Salary		18000
utility		8000
insurance		3000
depre	170000*0.9/10	15300
Total F. Costs		44300
NOI		18700
2a) Simple rate of return= NOI/cost of Oven and equipment
18700/170000=11%
2b) As per the simple rate of return is 11% and acceptability is at 10%, so Mr. Lugano must purchase oven and equipment
3a)Payback period = Cost of oven & equipment/Cash inflow per year
170000 / (18700+15300) = 5 years
3b) As per the payback period is 5 years and acceptability is at less than a seven years, so Mr. Lugano must purchase oven and equipment.