Wendell’s Donut Shoppe is investigating the purchase of a new $39,600 donut-maki

Question

Wendell’s Donut Shoppe is investigating the purchase of a new $39,600 donut-making machine. The new machine would permit the company to reduce the amount of part-time help needed, at a cost savings of $5,400 per year. In addition, the new machine would allow the company to produce one new style of donut, resulting in the sale of 2,500 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.

  

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

     

Find the internal rate of return promised by the new machine to the nearest whole percent.

     

In addition to the data given previously, assume that the machine will have a $14,000 salvage value at the end of six years. Under these conditions, compute the internal rate of return to the nearest whole percent. (Round discount factor(s) to 3 decimal places.)

     

Wendell’s Donut Shoppe is investigating the purchase of a new $39,600 donut-making machine. The new machine would permit the company to reduce the amount of part-time help needed, at a cost savings of $5,400 per year. In addition, the new machine would allow the company to produce one new style of donut, resulting in the sale of 2,500 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.

Explanation / Answer

Answer 1:

Total annual cash inflows associated with the new machine = Cost saving per year for part-time help + Increase in contribution per year

= $5,400 + $ 2,500 *2 = $10,400

Answer 2:

At internal rate of return PV of total inflows = PV to total outflows

Internal rate of return = 15%  

Answer 3:

Internal rate of return = 20%

Description Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Cost savings              5,400            5,400            5,400          5,400          5,400              5,400 New Contribution (2500*2)              5,000            5,000            5,000          5,000          5,000              5,000 Total cash inflow           10,400          10,400          10,400       10,400       10,400            10,400 P.V. factor @ 14.77%           0.8713          0.7592          0.6615       0.5764       0.5022            0.4376 Present Value        9,061.60      7,894.79      6,879.36    5,993.04    5,221.66        4,549.54 Total present value of cash inflows     39,600.00 Total present value of cash outflows     39,600.00

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