Internal Rate of Return Method A method of analysis of proposed capital investme
ID: 2448071 • Letter: I
Question
Internal Rate of Return Method
A method of analysis of proposed capital investments that uses present value concepts to compute the rate of return from the net cash flows expected from the investment.
—Two Projects
Cousin's Salted Snack Company is considering two possible investments: a delivery truck or a bagging machine. The delivery truck would cost $42,869.76 and could be used to deliver an additional 38,000 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 13,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be $36,510. 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 seven-year lives. The minimum rate of return is 9%. However, Cousin's has funds to invest in only one of the projects.
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
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.
Delivery Truck
Bagging Machine
Present value factor
___________
____________
Internal rate of return
___________%
___________%
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
Delivery Truck
Initial Investment = 42869.76
Annual Cash Flow = Additional No of Bag *contribution margin per Bag - delivery truck operating expenses
Annual Cash Flow = 38000*0.38 - 0.52*13000
Annual Cash Flow = $ 7680
At IRR
Initial Investment = Annual Cash Flow *PVIFA(IRR,7)
PVIFA(IRR,7) = Initial Investment/Annual Cash Flow
PVIFA(IRR,7) = 42869.76/7680
PVIFA(IRR,7) = 5.582
IRR = 6%
Bagging Machine
Initial Investment = 36510
Annual Cash Flow = No of Hour Saved *Direct Labor Rate
Annual Cash Flow = (250*3) * 10
Annual Cash Flow = $ 7500
At IRR
Initial Investment = Annual Cash Flow *PVIFA(IRR,7)
PVIFA(IRR,7) = Initial Investment/Annual Cash Flow
PVIFA(IRR,7) = 36510/7500
PVIFA(IRR,7) = 4.868
IRR = 10%
Answer
Delivery Truck Bagging Machine Present value factor 5.582 4.868 Internal rate of return 6% 10%Related Questions
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