Duddy Kravitz owns the Saint Viateur Bagel store. His world famous bagels are hand rolled, boiled in honey-water and baked in a wood-burning oven. The store sells 5,000 bagels per day and is open 365 days of the year

Question

The bagels are so popular that, on weekends, the customer line-up runs half-way down the block. Uncle Benjy thinks that the wood-fired oven should be replaced by a modern gas oven, which would reduce costs by $0.02 per bagel. A new oven would cost $105,000. Duddy is considering Uncle Benjy's idea, but he only plans to be in business for another two years. The bagels are sold for $0.75 each. The cost of producing each bagel with the wood-burning oven is $0.50 which includes labour and raw materials. The current oven was purchased thirty years ago for $20,000. It could be sold today for $5,000 and will be worth $3,000 in two years. A new oven costs $105,000 today and could be sold for $55,000 in two years. Duddy's cost of capital is 9%. Assume that investment cash flows occur immediately, and that sales and production costs occur at the end of the year. Assume that both ovens are classified as 10-year property and depreciated using the MACRS system. The tax rate is 35%. What is the NPV for the proposed acquisition if the cost of capital is 9%?

MACRS Depreciation Rates
Year 5-Year 7-Year 10-Year
1 20.00% 14.29% 10.00%
2 32.00% 24.49% 18.00%
3 19.20% 17.49% 14.40%
4 11.52% 12.49% 11.52%
5 11.52% 8.93% 9.22%

A) -$656
B) -$356
C) $356
D) $656
E) $956

Answer 1

B