Question

Purchasing a large oven and related equipment for mixing and baking “crazy bread” is being considered by Perotti’s Pizza. 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.	Perotti, the owner, estimates that purchase of the oven and equipment would allow the pizza parlour 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. Perotti 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 parlour uses straight-line depreciation on all assets, deducting salvage value from original cost.
d.	Perotti would like all projects to provide a return of at least 10%.
	(Ignore income taxes.)

Required:

1.	Prepare a contribution format income statement showing the operating income each year from production and sale of the crazy bread.

            

2-a.	Compute the simple rate of return for the new oven and equipment. (Round your answer to 2 decimal places.)

           

2-b.

Will this return be acceptable to Perotti?

	No
	Yes

3-a.	Compute the payback period on the oven and equipment.

            

3-b.

If any of the equipment has less than a seven-year payback, will Perotti purchase it?

	No
	Yes

References

Answer 1

1

Revenue: $90000. (60000*1.5)

Less Cost of good sold: $27000. (30% of revenue)

Gross Contribution Margin : $63000

Less Fixed expense :

Salaries $18000

Utilities $8000

Insurance $3000

Depreciation ($170000-$17000)/10 : $15300

Net Profit: $18700

Note: if salaries are classified as administrative expenses, then from gross contribution margin you have to subtract salaries to deduce net contribution margin and then we have to subtract other fixed expenses like utilities, insurance and depreciation to reach to net profit calculation