   Chapter 26, Problem 26.18EX

Chapter
Section
Textbook Problem

Internal rate of return method—two projects Munch N’ Crunch Snack Company is considering two possible investments: a delivery truck or a bagging machine. The delivery truck would cost $43,056 and could be used to deliver an additional 95,000 bags of pretzels per year. Each bag of pretzels can be sold for a contribution margin of$0.45. The delivery truck operating expenses, excluding depreciation, are $1.35 per mile for 24,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be$61,614. The new machine would require three fewer hours of direct labor per day. Direct labor is $18 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 13%. 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 present value of an annuity of$1 table appearing in this chapter (Exhibit 5). b. Provide a recommendation to management in a memo.

a.

To determine

Internal rate of return method:

Internal rate of return method is one of the capital investment method which determines the rate of return wherein the net present value of all the cash flows (both positive and negative) from an investment is zero. This method also called as the time-adjusted rate of return method, and it used to evaluate the different proposal’s expected rate of return.

To determine: The internal rate of return for the given project

Explanation

Delivery truck

The internal rate of return for the delivery truck is as follows:

Present value factor for an annuity of $1}=Amount to be investedEqual annual net cash flows (3)=$43,056$10,350=4.16 Working note: 1. Calculate the annual operating income: Operating income=No. of additional bags×Margin rate per bag=95,000 bags×$0.45=$42,750 (1) 2. Calculate the annual operating expense: Operating expense=No. of mile per year×Rate per mile=24,000 miles×$1.35=$32,400 (2) 3. Calculate the annual net cash flows: Annual net cash flow=Operating income (1)Operating expense (2)=$42,750$32,400=$10,350 (3)

Locate the number of years (7 years) of expected useful life of the investment in the year column, and find the present value factor (4

b.

To determine

To analysis: The investment in both project, and recommend the management by of creating memo.

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