Internal Rate of Return Method—Two Projects Cousin\'s Salted Snack Company is co
ID: 2497046 • Letter: I
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 $46,664.80 and could be used to deliver an additional 52,000 bags of pretzels per year. Each bag of pretzels can be sold for a contribution margin of $0.38. The delivery truck operating expenses, excluding depreciation, are $0.52 per mile for 18,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be $28,777.50. The new machine would require three fewer hours of direct labor per day. Direct labor is $10 per hour. There are 250 operating days in the year. Both the truck and the bagging machine are estimated to have eight-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 SelectgreaterlessItem 5 than the minimum rate of return requirement of 19% while the delivery truck rate of return was SelectgreaterlessItem 6 than the minimum rate of return requirement of 19%. Therefore the recommendation is to invest in the Selectbagging machinedelivery truckItem 7 .
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 4.192Explanation / Answer
a)
delivery truck
Additional cash flow per year
= Incremental contribution - incremental operating cost (excluding depreciation)
= $0.38 / bag x 52000 bags - $0.52 / mile x 18000 miles
= $19760 - $9360
= $10400
NPV at 15%
= PV of incremental cash inflow - cost of the delivery truck
= $10400 x PVIFA ( 15%, 8) - $ 46,664.80
= $10400 x 4.487 - $ 46,664.80
= $46664.80 - $ 46,664.80
= 0
As IRR is the discounting rate at which NPV of the project is zero,
IRR for the delivery truck = 15%
Bagging Machine
Additional cash flow per year
= Incremental contribution - incremental operating cost (excluding depreciation)
= $10/hour x 3 hours/day x 250 days
= $ 7500
NPV at 20%
= PV of incremental cash inflow - cost of the delivery truck
= $7500 x PVIFA ( 20%, 8) - $28,777.50
= $7500 x 3.837 - $28,777.50
= $ 28777.50 - $28,777.50
= 0
As IRR is the discounting rate at which NPV of the project is zero,
IRR for the bagging machine = 20%
b)
As the IRR is 20% for the bagging machine which is more than the required return of 19%, the investment should be made in the bagging machine.
delivery truck bagging machine present value factor 4.487 3.837 internal rate of return 15% 20%Related Questions
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