Denny Kean owns a very profitable ice cream stand. Based on the results of a $6,600 marketing research project, Denny is now considering adding a line of frozen yogurt to his product mix. Denny expects that the machine necessary to produce the yogurt will cost $130,000, last
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
Denny Kean owns a very profitable ice cream stand. Based on the results of a $6,600 marketing research
project, Denny is now considering adding a line of frozen yogurt to his product mix.
Denny expects that the machine necessary to produce the yogurt will cost $130,000, last for five years and
have a salvage value of $10,000 at the end of the fifth year. For tax purposes, Denny will
yogurt machine over the five years to a zero salvage value using the straight-line method.
Denny will incur extra annual fixed costs of $1,500 per year if he acquires this machine, while his variable
costs (the cone/cup, yogurt, wrapping paper, spoons, etc.) will be $0.50 per serving. He expects to sell
100 servings a day (365 days in a year) at a price per serving to be determined. The annual rent on his
stand under the existing noncancelable lease (with ten years remaining) is $18,000 per year, with built-in
annual increases to cover inflation (expected to be 3% annually).
The relevant income tax rate for Denny’s business is 30% (both for ordinary income and capital
gains/losses) and his cost of capital (same as MARR or “hurdle rate”) is 15%.
Required:
What is the lowest price that Denny could charge for a serving of yogurt and still justify acquiring the
machine? Show your work!!
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