Question

Wendell’s Donut Shoppe is investigating the purchase of a new $33,000 donut-making machine. The new machine would permit the company to reduce the amount of part-time help needed, at a cost savings of $5,700 per year. In addition, the new machine would allow the company to produce one new style of donut, resulting in the sale of 1,100 dozen more donuts each year. The company realizes a contribution margin of $2.60 per dozen donuts sold. The new machine would have a six-year useful life. Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables. Required: 1. What would be the total annual cash inflows associated with the new machine for capital budgeting purposes? 2. What discount factor should be used to compute the new machine’s internal rate of return? (Round your answer to 3 decimal places.) 3. What is the new machine’s internal rate of return? (Round your final answer to the nearest whole percentage.) 4. In addition to the data given previously, assume that the machine will have a $10,855 salvage value at the end of six years. Under these conditions, what is the internal rate of return? (Hint: You may find it helpful to use the net present value approach; find the discount rate that will cause the net present value to be closest to zero.) (Round your final answer to the nearest whole percentage.

Answer 1

Answer:

A. The cashflows for this project includes:

Year 0 initial outlay for equipment purchase -$33,000

Year 1-6 Net cash inflow of $8,560

Net cash inflow =

Part time help costs savings $5,700

Add contribution on incremental donuts sold$2,860

Total cash inflow =$8,560

B. The appropriate discount factor (internal rate of return) that provides a zero net present value = 14.3%

C. The IRR is 14%

D. With a salvage value of $10,855 the IRR becomes 19%

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