Kenny owns a very profitable ice cream stand. Based on the results of a marketing research project that cost $8,000, Kenny is now considering adding a line of frozen yogurt to his product mix.
Kenny expects that the machine necessary to produce the yogurt will cost $250,000, last for five years and have a salvage value of $20,000 at the end of the fifth year. For tax purposes, Kenny will depreciate the yogurt machine over the five years to a zero salvage value using the straight-line method.
Kenny will incur extra annual fixed costs of $3,000 per year if he acquires this machine, while his variable costs (the cone/cup, yogurt, wrapping paper, spoons, etc.) will be $1.00 per serving. He expects to sell 200 servings a day (365 days in a year) at a price per serving to be determined. The annual rent on his stand under the existing no cancelable lease (with seven years remaining) is $18,000 per year, with built-in annual increases to cover inflation (expected to be 3% annually).
The relevant income tax rate for Kenny's business is 40% (both for ordinary income and capital gains/losses) and his cost of capital (required rate of return or "hurdle rate") is 18%.
What is the lowest price that Kenny could charge for a serving of yogurt and still justify acquiring the machine