Internal Rate of Return Method—Two Projects Cousin\'s Salted Snack Company is co

Question

Internal Rate of Return Method—Two Projects

Cousin's Salted Snack Company is considering two possible investments: a delivery truck or a bagging machine. The delivery truck would cost $43,728.21 and could be used to deliver an additional 55,000 bags of pretzels per year. Each bag of pretzels can be sold for a contribution margin of $0.58. The delivery truck operating expenses, excluding depreciation, are $0.79 per mile for 19,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be $38,981.25. The new machine would require three fewer hours of direct labor per day. Direct labor is $15 per hour. There are 250 operating days in the year. Both the truck and the bagging machine are estimated to have four-year lives. The minimum rate of return is 19%. However, Cousin's has funds to invest in only one of the projects.

a. Compute the internal rate of return for each investment. Use the above table of present value of an annuity of $1. If required, round your present value factor answers to three decimal places and internal rate of return to the nearest percent.

b. The bagging machine rate of return was

than the minimum rate of return requirement of 19% while the delivery truck rate of return was than the minimum rate of return requirement of 19%. Therefore the recommendation is to invest in the .

Present Value of an Annuity of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.352 2.991 6 4.917 4.355 4.111 3.784 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192

Explanation / Answer

a) Present value factor

DELIVERY TRUCK

=P(1-(1+r)-n/r)

=10229.593

BAGGING MACHINE

=P(1-(1+r)-n/r)

=9119.109

INTERNAL RATE OF RETURN

DELIVERY TRUCK

0=(Cash flow/(1+r)n-initial investment

0=(10229.593/(1+r)4)-43728.21

IRR=12.95%

BAGGING MACHINE

0=(Cash flow/(1+r)n-initial investment

IRR=13.09%

b) The company should not invest as the MRR is 19% which is more than the IRR which is being calculated.

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