Wendell’s Donut Shoppe is investigating the purchase of a new $52,000 donut-maki

Question

Wendell’s Donut Shoppe is investigating the purchase of a new $52,000 donut-making machine. The new machine would permit the company to reduce the amount of part-time help needed, at a cost savings of $6,900 per year. In addition, the new machine would allow the company to produce one new style of donut, resulting in the sale of 1,800 dozen more donuts each year. The company realizes a contribution margin of $2.50 per dozen donuts sold. The new machine would have a six-year useful life.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

What would be the total annual cash inflows associated with the new machine for capital budgeting purposes?

Wendell’s Donut Shoppe is investigating the purchase of a new $52,000 donut-making machine. The new machine would permit the company to reduce the amount of part-time help needed, at a cost savings of $6,900 per year. In addition, the new machine would allow the company to produce one new style of donut, resulting in the sale of 1,800 dozen more donuts each year. The company realizes a contribution margin of $2.50 per dozen donuts sold. The new machine would have a six-year useful life.

Explanation / Answer

1. the total annual cash inflows: Annual saving in part help = $6900

Added contribution margin from expanded sales = $4500

Annual Cash Inflows =$11400

2. Internal rate of return = ( Total Cash Outflow / Total Cash Inflows ) * Number of years

= $52000 / ( $11400 * 6 ) * 6 years = 4.56% or 5%

3. Machine with salvage value of $16835, the Internal rate of return =

=  $52000 / [( $11400 * 6 ) + $16835] * 6 years = 3.66% or 4%

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