Champion Bakers uses specialized ovens to bake its bread. One oven costs $689,000 and lasts about 4 years before it needs to be replaced. The annual operating cost per over is $41,000. What is the equivalent annual cost of an oven if the required rate of return is 13 percent?

Question

Quizplus · Accepted Answer

The equivalent annual cost of an oven is the sum of the annual operating cost and the capital recovery cost. The capital recovery cost is the annual payment that would be required to repay the cost of the oven over its useful life, plus interest on the unpaid balance. The capital recovery cost can be calculated using the following formula:Capital recovery cost = (P * r) / (1 - (1 + r)^-n)where:P = the cost of the ovenr = the required rate of returnn = the useful life of the ovenIn this case, the cost of the oven is $689,000, the required rate of return is 13%, and the useful life of the oven is 4 years. Therefore, the capital recovery cost is:Capital recovery cost = (689,000 * 0.13) / (1 - (1 + 0.13)^-4)= $232,407The equivalent annual cost of an oven is therefore:Equivalent annual cost = annual operating cost + capital recovery cost= $41,000 + $232,407= $272,638

Champion Bakers Uses Specialized Ovens to Bake Its Bread