The Elberta Fruit Farm of Ontario always has hired transient workers to pick its
ID: 2806651 • Letter: T
Question
The Elberta Fruit Farm of Ontario always has hired transient workers to pick its annual cherry crop. Janessa Wright, the farm manager, just received information on a cherry picking machine that is being purchased by many fruit farms. The machine is a motorized device that shakes the cherry tree, causing the cherries to fall onto plastic tarps that funnel the cherries into bins. Ms. Wright has gathered the following information to decide whether a cherry picker would be a profitable investment for the Elberta Fruit Farm a. Currently, the farm is paying an average of $290,000 per year to transient workers to pick the cherries. b. The cherry picker would cost $680,000, and it would have an estimated 10-year useful life. The farm uses straight-line depreciation on all assets and considers salvage value in computing depreciation expense. The estimated salvage value of the cherry picker is $70,000 c. Annual out-of-pocket costs associated with the cherry picker would be: cost of an operator and an assistant, $84,000; insurance, $3,000; fuel, $11,000; and a maintenance contract, $14,000. Click here to view Exhibit 138-1 and Exhibit 13B-2, to determine the appropriate discount factor using tables. Required: 1. Determine the annual savings in cash operating costs that would be realized if the cherry picker were purchased 2a. Compute the simple rate of return expected from the cherry picker. 2b. would the cherry picker be purchased if Elberta Fruit Farm's required rate of return is 20%? 3a. Compute the payback period on the cherry picker. 3b. The Elberta Fruit Farm will not purchase equipment unless it has a payback period of four years or less. Would the cherry picker be purchased? 4a. Compute the internal rate of return promised by the cherry picker 4b. Based on this computation, does it appear that the simple rate of return is an accurate guide in investment decisions?Explanation / Answer
Answer:-
Answer-1:-
$290,000 is average yearly pay to transient worker.
Annual cost of cherry picker unit is $112,000 which includes operator and an assistant cost of $84000, insurance of $3000, fuel cost of $11000 and maintenance cost of $14000. ($84000 + $11000 + $3000 + $14000 = $112,000)
Also, cherry picker unit has yearly straight line depreciation value saving of $680000 calculated for unit value of $680,000 for 10 year asset life. ($680,000 / 10 = $68000). Hence annual cost of the unit is $44000 calculated by reducing annual cost with depreciation amount ($112,000 - $68000 = $44000).
Hence, the annual cost saving realised on purchase of unit is $246,000 calculated by deducting annual cost and depreciation amount saving of unit from annual cost of transient workers ($290,000 - $44000 = $246,000).
We could be considering the cost saving excluding depreciation as depreciation is accounting value used for repurchase capability of assets post end of asset life hence it is advisable to exclude it.
Hence, the annual cost saving realised on purchase of unit is $178,000 calculated by deducting annual cost of unit from annual cost of transient workers ($290,000 - $112,000 = $178,000).
Answer-2a:-
Simple Rate of return expected from the unit is 25.80% arrived by dividing annual cost saving from purchasing unit and cost of unit ([$178000 / $690000] x 100 = 25.80%).
Answer-2b:-
Yes, as it is giving simple Rate of return of 25.80%.
Answer-3a:-
Payback Period of unit is 3.87 calculated by dividing cost of unit by annual cost saving ($690,000 / $178,000 = 3.87).
Answer-3b:-
The unit should be purchased as payback Period is less than or around 4 years.
Answer-4a:-
The link given in question for discount Rate is not opening hence cannot arrive at IRR.
Answer-4b:-
IRR is one way to arrive at capital investment decision hence simple rate of return is not accurate measure but tentative calculation measure. Better decision could be arrived with simple Rate of return together with Net Present Value (NPV), IRR, Payback Period.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.