EXERCISE13-2 Internal Rate of Return Wendell\'s Donut Shoppe is investigating th

Question

EXERCISE13-2 Internal Rate of Return
Wendell's Donut Shoppe is investigating the purchase of a new $18,600 donut-making machine. The new machine would permit the company to reduce the amount of part-time help needed, at a cost savings of$3,800 per year. In addition, the new machine would allow the company to produce one new style of donut, resulting in the sale of 1,000 dozen more donuts each year. The company realizes a contribution margin of
$1.20 per dozen donuts sold. The new machine would have a six-year useful life.

Explanation / Answer

Machin cost is $18600. So In Y0, Cash Flow is -18600 In Year 1 : EBIT is $3800 Savings + $1.20*1000 Revenue - Depreciation (18600/6) So EBIT Inflow from Y1 to Y6 = 3800+1200-3100 = 1900 SO Net Income (Cash Inflows) from Y1 to Y6 = EBIT + Dep written back = 1900+3100 = 5000 IRR is the Rate of return when NPV is zero. Using IRR function in excel, we get Rate of Return = IRR(CFs) ie Int Rate of Return = IRR(-18600,5000,5000,5000,5000,5000,5000) Ie Int Rate of Return = 10.74%

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