Hank’s Coffee House located downtown Toronto is considering investing in a new oven that would allow them to make freshly baked pastries. Three years ago they already purchased a small and cheap oven for $1,000 (in nominal terms), which broke down and had to be disposed
five months later. Today, management is considering the professional stainless steel Bertazzoni X486GGGVX gas oven, which costs $15,540. Because it runs on gas, a technician needs to come in to install the oven. This costs $400. The oven lasts for 4 years. The estimated market value four years from now is $8,000 in real terms. The CCA rate is 20%. After the oven is sold, Hank’s Coffee House has no other equipment in this asset class. Management expects to sell 11,000 pastries per year. The price of a pastry in year one is $2.50 in nominal terms and is expected to increase by 2% per year in real terms. The costs of a pastry in year one are $0.50 in nominal terms, which are also expected to increase by 2% per year in real terms. This project requires higher inventory levels: at the beginning of each year, inventories (in nominal terms) should be 25% of the nominal sales at the end of that year. Because of the expected increase in sales, Hank’s Coffee House will need to hire one extra part‐time employee, with a real salary of $20,000 per year, which remains constant in real terms. Revenues and costs (including labor costs) all occur at the end of each year. The real discount rate is 8%. Over the past 3 years, annual inflation was 2.2% per year. The expected inflation rate for the next 4 years is 2.5% per year. The tax rate is 32%. Calculate the project’s NPV.