Question

Wendell’s Donut Shoppe is investigating the purchase of a new $48,300 donut-making machine. The new machine would permit the company to reduce the amount of part-time help needed, at a cost savings of $6,800 per year. In addition, the new machine would allow the company to produce one new style of donut, resulting in the sale of 1,700 dozen more donuts each year. The company realizes a contribution margin of $2.00 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.

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 answers to 3 decimal places.)

3. What is the new machine’s internal rate of return to the nearest whole percent?

4. In addition to the data given previously, assume that the machine will have a $15,685 salvage value at the end of six years. Under these conditions, what is the internal rate of return

Answer 1

Part 1

Total annual cashflows = savings+added contribution margin from expanded sales = 6800+(1700*2)= 10200

Part B

Factor of internal rate of return = investment required/ annual cashflows= 48300/10820=4.735

part C

IRR = 7%

IRR can be calculated using Excel formula IRR

You have to put all cash flows from year 0-6 in a subsequent rows in the following manner

-48300

10200

10200

10200

10200

10200

10200

Now apply IRR formula

=IRR(select all above values) and press enter you will get answer as 7%

PART D

IRR = 13%

It will be calculated in the same manner as above only the cash flow of year 6 will be (10200+15685)= 25885