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 depreciate the 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!!
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 depreciate the 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!!
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text: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 depreciate the 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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