Question

Joey's Pizza Parlor is considering the purchase of a large oven and related equipment for mixing and baking Joey's Favorite Bread. The oven and equipment would cost $150,000 delivered and installed. It would be usable for about 15 years, after which it would have a 10% scrap value.

The following additional information is available.

• Joey estimates that the purchase of the oven and equipment would allow the pizza parlor and restaurant to bake and sell 90,000 loaves of crazy bread each year. The sells for $1.85 per loaf.
• The cost of the ingredients in a loaf of bread is 45% of the selling price. Joey estimates that other costs each year associated with the bread would be as follows: salaries, $22,000; utilities, $10,000; and insurance, $4,000.
• The pizza parlor will use the straight-line depreciation on all assets, deducting salvage value from original cost.

1. Prepare a contribution format income statement showing the net operating income each year from production and sale of Joey’s Favorite Bread.
2. Compute the simple rate of return for the new oven and equipment. If a simple rate of return above 12% is acceptable to Joey, will he purchase the oven and equipment?
3. Compute the payback period on the oven and equipment. If Joey purchases any equipment with less than a 6-year payback, will he purchase this equipment?

Answer 1

Joey's Pizza Parlor
contribution format income statement	(EACH YEAR)
PARTICULARS		TOTAL	PER UNIT
SALES(90,000 LOAVES)		$166,500	$1.85
VARIABLE COST(45%)		$74,925	$0.83
		$91,575
LESS: FIXED COST
SALARIES	22,000
UTILTIES	10,000
INSURANCE	4,000
DEPRECIATION	9,000*
TOTAL FIXED COST		45,000
NET OPERATING INCOME		46,575

SIMPLE RATE OF RETURN = ANNUAL NET OPERATING INCOME/INITIAL INVESTMENT

= 46,575/150,000

=31.05%

IT IS ACCEPTABLE TO JOEY, HE WILL PURCHASE THE EQUIPMENT

PAYBACK PERIOD = INITAIL INVESTMENT/NET CASH INFLOWS

= 150,000/55,575*

= 2.7 YEARS

YES HE WILL PURCHASE THIS EQUIPMENT

*DEPRECIATION = 150,000-15,000/15

=9,000

NET CASH INLOWS= NET OPERATING INCOME + DEPRECIATION

= 46,575 + 9,000

= 55,575