Question

Internal Rate of Return Method—Two Projects

Strahn Foods Inc. is considering two possible investments: a delivery truck or a bagging machine. The delivery truck would cost $41,767.76 and could be used to deliver an additional 50,000 bags of taquitos chips per year. Each bag of chips can be sold for a contribution margin of $0.38. The delivery truck operating expenses, excluding depreciation, are $0.52 per mile for 17,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be $36,877.50. 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 six-year lives. The minimum rate of return is 11%. However, Strahn Foods 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	3.353	2.991
6	4.917	4.355	4.111	3.785	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. Enter the present value factor to three decimal places.

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

b. Which of the following should be included in a memo to management regarding the recommendation about the two projects?
The bagging machine fails to exceed the minimum rate of return requirement.

Feedback

a. Determine the net cash flow for the delivery truck by subtracting the cash paid (operating expenses) from the cash received from additional deliveries. For each investment, divide the amount to be invested by the annual net cash flows. In the table, find the rate of returnclosest to this factor. Determine the net cash flow for the bagging machine by calculating the direct labor savings (hours per day × days per year × hourly rate).

b. Review the evaluation criteria for an internal rate of return analysis.

Answer 1

a
	Delivery Truck	Bagging Machine
Present value factor	4.111	4.917
Internal rate of return	12%	6%
b
The bagging machine fails to exceed the minimum rate of return requirement.
Workings:
Annual cash flows:
Delivery Truck	10160	=(50000*0.38)-(17000*0.52)
Bagging Machine	7500	=3*10*250
	Delivery Truck	Bagging Machine
Present value factor	=41767.76/10160	=36877.50/7500