Wendell’s Donut Shoppe is investigating the purchase of a new $33,000 donut-maki

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 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 $10,855 salvage value at the end of six years. Under these conditions, what is the internal rate of return? (Round your final answer to nearest whole percentage.)

Explanation / Answer

1. Annual savings in part Time help 5,700

Additional contribution margin from expected sales (1100 X 2.6) 2860

Annual Cash Fow 8560

2)  discount factor should be used to compute the new machine’s internal rate of return

33000 / 8560 = 3.855

3) 3.855 is a present value annuity at 15%

so, the IRR = 15%

4) Annual cash flow = 8560

Depreciation = 3690.833 (33000 - 10855 / 6)

Cash flow = 8560 + 3690.833 = 12250.833

Internal rate of return = 33000 / 12250.833 = 2.693 (factor for 6 years)

therefore internal rate of return = 29%

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