Question

Internal Rate of Return Method—Two Projects

Cousin's Salted Snack Company is considering two possible investments: a delivery truck or a bagging machine. The delivery truck would cost $47,766.00 and could be used to deliver an additional 45,000 bags of pretzels per year. Each bag of pretzels can be sold for a contribution margin of $0.58. The delivery truck operating expenses, excluding depreciation, are $0.79 per mile for 15,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be $22,432.50. The new machine would require three fewer hours of direct labor per day. Direct labor is $10 per hour. There are 250 operating days in the year. Both the truck and the bagging machine are estimated to have five-year lives. The minimum rate of return is 19%. However, Cousin's has funds to invest in only one of the projects.

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	4.192

a. Compute the internal rate of return for each investment. Use the above table of 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.

	Delivery Truck	Bagging Machine
Present value factor
Internal rate of return	%	%

b. The bagging machine rate of return was SelectgreaterlessItem 5 than the minimum rate of return requirement of 19% while the delivery truck rate of return was SelectgreaterlessItem 6 than the minimum rate of return requirement of 19%. Therefore the recommendation is to invest in the Selectbagging machinedelivery truckItem 7 .

Answer 1

Annual cash flows Delivery Truck =(45000*0.58)-(15000*0.79)= $14250

Annual cash flows Bagging Machine = 3*10*250= $7500

a

Delivery Truck

Bagging Machine

Present value factor

3.352

2.991

Internal rate of return

15%

20%

b

The bagging machine rate of return was greater than the minimum rate of return requirement of 19% while the delivery truck rate of return was less than the minimum rate of return requirement of 19%. Therefore the recommendation is to invest in the bagging machine.