Munch N’ Crunch Snack Company is considering two possible investments: a deliver
ID: 2571674 • Letter: M
Question
Munch N’ Crunch Snack Company is considering two possible investments: a delivery truck or a bagging machine. The delivery truck would cost $27,442.8 and could be used to deliver an additional 40,000 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 14,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be $35,662.5. The new machine would require three fewer hours of direct labor per day. Direct labor is $15 per hour. There are 250 operating days in the year. Both the truck and the bagging machine are estimated to have four-year lives. The minimum rate of return is 9%. However, Munch N’ Crunch 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 The sum of the present values of a series of equal cash flows to be received at fixed intervals.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.
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
Munch N Crunch Snack Company
Basic Calculations –
Investment projects
Delivery Truck
Bagging Machine
Cost
$27,442.8
$35,662.50
Additional Contribution
(At $0.38 per bag, 40,000 bags
$15,200
Savings in direct labor hours
(3hrs at $15 per hour for 250 hrs)
$11,250
Operating expenses
(at $0.52 per mile, 14,000 miles
$7,280
Net Additional Earnings per year
$7,920
$11,250
Estimated useful life
4 years
4 years
Computation of internal rate of return:
Internal rate of return (IRR) is the discount rate at which the NPV of the project equals to zero.
NPV (net present value) = present value of cash flows from an investment – initial investment
Use trial and error method to arrive at IRR
Since the given minimum rate of return for the company is 9%, the IRR should be closer
Calculating NPV for 6% discount rate,
Delivery Truck
Bagging Machine
initial investment
($27,442.8)
($35,662.5)
Annual cash inflows
$7,920
$11,250
Annuity value of $1 for 4 years
3.465
3.465
Annuity of cash inflows
27,442.8
$38,981.25
NPV
0
$3,328.8
Since the NPV of Delivery Truck is 0 at 6% discount rate, IRR for delivery truck is 6%.
At 6% discount rate, Bagging Machine NPV is higher.
So, the IRR for Bagging Machine would be much higher.
Calculating NPV of Bagging Machine at a discount rate of 10%,
Annuity of $1 at 10% for year 4 = 3.17
Annuity of cash inflows, $11,250 at 10% discount rate = 11,250 x 3.17 = $35,662.5
Present value of initial investment in year 0 = $35,662.5 x 1 = ($35,662.5)
NPV for Bagging Machine =0
Hence, IRR for Bagging Machine is 10%
Delivery Truck
Bagging Machine
Present Value Factor
3.465
3.17
Internal Rate of Return
6%
10%
Since, the company has funds to invest in only one option, the profitable option is investment in Bagging Machine.
Explanation:
The IRR of Bagging Machine – 10% is higher than the IRR of Delivery Truck – 6%. Since the company’s minimum rate of return is 9%, the company should choose to invest in Bagging Machine, which has a higher IRR (10%) compared to the minimum rate of return, 9%.
Investment projects
Delivery Truck
Bagging Machine
Cost
$27,442.8
$35,662.50
Additional Contribution
(At $0.38 per bag, 40,000 bags
$15,200
Savings in direct labor hours
(3hrs at $15 per hour for 250 hrs)
$11,250
Operating expenses
(at $0.52 per mile, 14,000 miles
$7,280
Net Additional Earnings per year
$7,920
$11,250
Estimated useful life
4 years
4 years
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