PepperoniPizza Company owns and operates fast-service pizza parlors throughout North America. The firm operates on a regional basis and provides almost complete autonomy to the manager of each region. Regional managers are responsible for long-range planning, capital expenditures, personnel policies, pricing, and so forth. Each year the performance of regional managers is evaluated by determining the accounting return on fixed assets in their regions; a return of 16% is expected. To determine this return, regional net income is divided by the book value of fixed assets at the start of the year. Managers of regions earning a return of more than 18% are identified for possible promotion, and managers of regions with a return of less than 14% are subject to replacement. New investments are required to have a payback of period of 3 years. Mr. Light, with a degree in hotel and restaurant management, is the manager of the Northeast region. He is regarded as a “rising star” and will be considered for promotion during the next two years. Light has been with Pepperoni for a total of three years. During that period, the return on fixed assets in his region (the oldest in the firm) has increased dramatically. He is currently considering a proposal to open five new parlors in the Boston area. The total project involves an investment of $1,100,000 and is expected to increase the number of Pepperoni pizzas sold in the Northeast region to a total of 600,000 in the first year and increase by 3% each year after that. The pizzas are sold at an average price of $9 each. The expenses of operating each of the new parlors include variable costs of $5 per pizza and fixed costs (including depreciation) of $215,600 per year – Pepperoni uses straight line depreciation. Each of the new parlors has only a five-year life and salvage value of $85,000. 

Required 

A) Evaluate the desirability of the $1,100,000 investment in new pizza parlors by computing the 

a) Accounting Rate of Return (see case for method used by Pepperoni) 

b) Payback Period 

c) Internal rate of return, and 

d) Net present value. Assume a time value of money of 16%. 

B) If Light is shrewd, will he approve the expansion? Why or why not? Explain what you believe Light is likely to do and the implications for the company. • Tip - examine your results in part (a) and read the case very carefully to answer this question.

Answer rating: 100% (QA)

Initial investment 1100000 Salvage value 85000 Life of project 5 years Depreciation Investment Salvage value Useful life 1100000 85000 5 203000 per ye... View the full answer