Reference no: EM132617523

Question - Los Pollos sells takeaway chicken and related products. The manager, Gus Fring, is considering acquiring an advanced new oven which will substantially reduce the time required to cook chicken and would also enable the store to diversify into the sale of pizza. The cost of the new oven is $55,000. Los Pollos has estimated the oven will have a useful life of five years and will attract annual cash flows of $18,000 in year 1; $25,000 in year 2; $35,000 in year 3; $10,000 in year 4; and $2,000 in year 5.

It is estimated the oven will be sold for $2,000 at the end of its useful life (scrap value).

Los Pollos has a cost of capital equal to 9% and management prefer projects with a payback period of less than 3 years.

Required -

1. Calculate the Net Present Value (NPV) of the project.

2. Calculate the Payback Period (PP) of the project.

3. Based on your calculations of NPV and PP, should the management of Los Pollos proceed with the purchase of the oven? Explain shortly why (or why not)?

4. Does the internal rate of return (IRR) equal the cost of capital in this example. Explain shortly why (or why not)?

5. Explain how you would estimate the internal rate of return without accurate calculations.

6. Another investment option for the manager of Los Pollos is to purchase a frying machine for $40 000. The machine is expected to earn annual net cash inflows of $20 000, $30 000, $15 000, and $20 000, before it wears out sufficiently to be unreliable and must be sold for an estimated $10 000. Compare this investment to the investment into the oven. Based on your analysis, explain which investment you would recommend to the manager of Los Pollos.