The Williams Company has been operating a small lunch counter for the convenience of employees. The counter occupies space that is not needed for any other business purpose. The lunch counter has been managed by a part-time employee whose annual salary is $3,000. Yearly operations have consistently shown a loss as follows:
Receipts $20,000
Expenses for food, supplies (in cash) $19,000
Salary 3,000 22,000
Net Loss $(2,000)
A company has offered to sell Williams Company automatic vending machines for a total cost of $12,000. Sales terms are cash on delivery. The old equipment has zero disposal value.
The predicted useful life of the equipment is 10 years, with zero scrap value. The equipment will easily serve the same volume that the lunch counter handled. A catering company will completely service and supply the machines. Prices and variety of food and drink will be the same as those that prevailed at the lunch counter. The catering company will pay 5 percent of gross receipts to the Williams Company and will bear all costs of food, repairs, and so forth. The part-time employee will be discharged. Thus, Williams Company's only cost will be the initial outlay for the machines.
Consider only the two alternatives mentioned. Present value tables or a financial calculator are required.
Required:
a. What is the annual income difference between alternatives?
b. Compute the payback period.
c. Compute:
1. The net present value if relevant cost of capital is 20 percent.
2. Internal rate of return.
d. Management is very uncertain about the prospective revenue from the vending equipment. Suppose that the gross receipts amounted to $14,000 instead of $20,000. Repeat the computation in part c.1.
e. What would be the minimum amount of annual gross receipts from the vending equipment that would justify making the investment? Show computations.