The Springfever Restaurant specializes in beer and pizza to go. The manager thinks that the sales volume of the restaurant can be increased if the existing pizza oven is replaced with a new conveyor oven, which will reduce cooking time by 50%. The new oven would have an initial cost of $10,000 and an ex- pected life of 10 years. It would be depreciated using straight-line depreciation, assuming Zero salvage value. The existing pizza oven is fully depreciated. The expected increase in cash revenue (AR,) is a constant $25,000 per year. The ex- pected increase in cash expenses (AE,) is a constant $23,000 per year. The beta of the new oven is estimated to be 1.4 (which is slightly higher than the beta of the existing restaurant). The risk-free rate is 10%, the expected return on the market portfolio is 20%, and the cost of debt is 10%. The oven will be financed with 50% debt and 50% equity. The restaurant uses the WACC approach to evaluating new projects and has a tax rate of 40%.

Required:

1. Calculate the owners’ required rate of return on the investment in the new oven.

2. Calculate the weighted average cost of capital for the project.

3. Calculate the annual after-tax operating cash flows that would be generated by the investment in the new oven.

4. Put all of the relevant cash flows from the investment on a time line.

(Assume that the old oven has zero resale value.)

5. Calculate the NPV of the investment in the new oven and explain why the Springfever should or should not purchase the new oven.