When to replace an asset: Burt's Pizzas is considering whether to purchase an oven. Burt's calculates that its current oven generates $4,000 of cash flow per year. A new oven would cost $15,000 and would provide cash flow of $6,000 per year for six years. What is the equivalent annual cash flow for the new oven (round to the nearest dollar), and should Burt's purchase the new oven? Assume the cost of capital for Burt's is 12 percent.

Question

Quizplus · Accepted Answer

The equivalent annual cash flow (EAC) for the new oven is calculated using the formula for the annuity: EAC = (NPV * r) / (1 - (1 + r)^-n). The NPV of the new oven is calculated as the difference between the present value of cash flows and the cost. The EAC is approximately $2,352, which is less than the current oven's cash flow of $4,000, so Burt's should not purchase the new oven.

When to Replace an Asset: Burt's Pizzas Is Considering Whether