Evaluate Two Ovens For Tink The Tinkerer

Evaluate Two Ovens for Tink The Tinkers

Evaluate Two Ovens for Tink The Tinkers

Your boss has asked you to evaluate two oven options for Tink—the Tinkers, a gourmet sandwich shop. After gathering specifications and questioning vendors, you have details about the attributes and costs of each oven, summarized in the following table. You are asked to determine which oven to recommend using the present value method, given the assumptions that the lifespan of each machine is five years and that the company's desired rate of return is 14%, reflecting an investment risk similar to this project.

The attributes and costs for each oven are as follows:

  • Three small ovens at $1,250 each (original cost)
  • Two large ovens at $2,500 each (original cost)
  • Labor per year in excess of large models: $750 (total)
  • Cleaning/maintenance costs per oven per year: $[] (to be specified)
  • Salvage value at the end of 5 years per oven: $[] (to be specified)

Paper For Above instruction

In evaluating whether to purchase the small or large ovens for Tink—the Tinkers, it is essential to apply a structured financial analysis leveraging the present value (PV) method. This approach considers initial investments, recurring costs, salvage values, and the company's targeted return rate to determine the most economically advantageous option. Accordingly, we systematically analyze each alternative, incorporating all relevant cash flows and assumptions outlined in the problem description.

Methodology and Assumptions

The analysis operates under the assumption that both oven types will serve the operation for exactly five years, aligning with the typical lifespan of commercial kitchen equipment and simplifying the evaluation. The rate of 14% represents the company's required rate of return, considering this project’s risk level. It is assumed that the cash flows—initial costs, annual expenses, and salvage values—occur at specific intervals, and discounting them to their present values allows comparison of overall costs and benefits.

Cost and Investment Analysis

The initial investment comprises the purchase costs of the ovens. For the small ovens, three units cost 3 × $1,250 = $3,750. The larger ovens cost 2 × $2,500 = $5,000. Since labor costs are ongoing annual expenses supplementary to the ovens’ purchase prices, they are incorporated into annual operating costs, which also include cleaning and maintenance expenses. The salvage value at the end of five years provides residual worth, which reduces the net expenditure over the oven’s life.

Present Value Calculations

The core calculations involve discounting all cash flows—initial costs, annual expenses, and salvage values—to the present. Using the discount rate of 14%, the present value of the annual costs is calculated through the annuity formula. The present value of the salvage value is discounted back to the present at the same rate.

The comparison between the total present costs of each oven type will identify the more economical choice. Typically, the option with the lower total present value of costs is deemed preferable. Notably, assumptions about the accuracy of salvage values and consistent annual expenses underpin this calculation. If these assumptions differ significantly, the recommendation may need adjustment.

Conclusion and Recommendation

After computing the present values based on the specific costs and salvage values, the oven option with the lesser present cost should be recommended. This analysis facilitates informed decision-making aligned with the company’s financial goals and risk appetite by quantifying the long-term costs associated with each equipment option.

References

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