Investment Project Scenario
Pizza Palace is a pizza restaurant known for its posh décor and its
ick-oven pizza. Pizza Palace has five
ick ovens that need attention and is considering two options. Both options will cost around $1,000,000. Option 1 is to refu
ish its cu
ent
ick-ovens. If refu
ished, Pizza Palace expects the ovens to last another 6 years. Option 2 is to replace the cu
ent ovens. New ovens would last 8 years and have no residual value. Pizza Palace expects the following net cash inflows from the two options:
Yea
Refu
ish Cu
ent Ovens
Purchase New Ovens
1
$600,000
$800,000
2
$500,000
$600,000
3
$400,000
$300,000
4
$300,000
$200,000
5
$200,000
$100,000
6
$100,000
$50,000
7
$50,000
8
$50,000
Pizza Palace uses straight-line depreciation and requires an annual return of 10%
Requirements:
1. Calculations: Please use the provided Excel Template to calculate the payback, the ARR, the NPV, and profitability index for both options. (80 points)
2. Decision Write up: On a Word Document write (in 100 words or more) which option the company should choose and why. (70 points)
a. Please include the following information in your decision write up:
i. What is payback period? Based on payback period alone which option should the company choose? Why?
ii. What is the Accounting Rate of Return (ARR)? Based on ARR alone which option should the company choose? Why?
iii. What is Net Present Value (NPV)? Based on NPV alone which option should company choose? Why?
iv. What is the profitability index? Based on profitability index alone which option should the company choose? Why?
v. Based on all the calculations which option would you recommend the company choose? Why?
Sheet1
Name:
Payback:
Refu
ish Cu
ent Machine
Net Cash Outflows Refu
ish Cu
ent Machine Net Cash Inflows Refu
ish Cu
ent Machine
Year Amount Invested Annual Accumulated
0
1
2
3
4
5
6
7
8
Payback for Refu
ishing the cu
ent machine = Years + ÷ = ERROR:#DIV/0! Years
Purchase New Machine
Net Cash Outflows Purchase New Machine Net Cash Inflows Purchase New Machine
Year Amount Invested Annual Accumulated
0
1
2
3
4
5
6
7
8
9
10
Payback for Purchasing a new machine = Years + ÷ = ERROR:#DIV/0! Years
Accounting Rate of Return (ARR):
Refu
ishing Cu
ent Machine
Average Annual Income from Capital Investment:
Total net cash inflows during the operating life of the asset
Less: Total depreciation during the operating life of the asset (Cost - Residual Value)
Total operating income during operating life 0
Divided by: Asset's operating life in years
Average annual operating income from asset ERROR:#DIV/0!
Average amount invested: = + ÷ = ERROR:#DIV/0!
ARR of Refu
ishing Cu
ent Machine = ÷ = ERROR:#DIV/0!
Purchasing New Machine
Average Annual Income from Capital Investment:
Total net cash inflows during the operating life of the asset
Less: Total depreciation during the operating life of the asset (Cost - Residual Value)
Total operating income during operating life 0
Divided by: Asset's operating life in years
Average annual operating income from asset ERROR:#DIV/0!
Average amount invested: = + ÷ = ERROR:#DIV/0!
ARR of Purchasing New Machine = ÷ = ERROR:#DIV/0!
Net Present Value
Refu
ishing Cu
ent Machine
Years
Present value of each year's inflow: Net Cash inflow Present Value Factor** Present Value ** See table below
1 (n = 1) 0
2 (n = 2) 0
3 (n = 3) 0
4 (n = 4) 0
5 (n = 5) 0
6 (n = 6) 0
7 (n = 7) 0
8 (n = 8) 0
Total PV of cash inflows 0
0 Initial Investment
Net Present Value of Refu
ishing Cu
ent Machine 0
Purchasing New Machine
Years
Present value of each year's inflow: Net Cash inflow Present Value Factor** Present Value ** See table below
1 (n = 1) 0
2 (n = 2) 0
3 (n = 3) 0
4 (n = 4) 0
5 (n = 5) 0
6 (n = 6) 0
7 (n = 7) 0
8 (n = 8) 0
9 (n = 9) 0
10 (n = 10) 0
Total PV of cash inflows 0
0 Initial Investment
Net Present Value of Purchasing New Machine 0
Profitability Index:
Project: Present value of net cash inflows ÷ Initial Investment = Profitability Index
Refu
ish Cu
ent Machine ERROR:#DIV/0!
Purchase New machine ERROR:#DIV/0!