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

question 90

Multiple Choice

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.

• A) $2,352, do not purchase the oven
• B) $6,000, purchase the oven
• C) $9,668, purchase the oven
• D) $24,668, purchase the new oven

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Definitions:

Downside Risk

The potential loss in value of an investment, indicating the estimate of the extent to which an asset or security could decrease in value.

Conversion Premium

The extra amount an investor pays to convert a convertible security into a specified number of shares of common stock, above its current market value.

Conversion Price

The predetermined price at which convertible securities can be exchanged for a specified number of common shares.

Current Stock Price

The price at which a stock is trading on the stock market at any given time.