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 $31,525.14 and could be used to deliver an additional 51,000 bags of pretzels per year. Each bag of pretzels 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 $31,590. 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, Munch N’ Crunch 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 less than the minimum rate of return requirement of 19% while the delivery truck rate of return was greater than the minimum rate of return requirement of 19%. Therefore the recommendation is to invest in the delivery truck .
a | ||
Delivery Truck | Bagging Machine | |
Present value factor | 2.991 | 4.212 |
Internal rate of return | 20% | 6% |
b | ||
The bagging machine rate of return was less than the minimum rate of return requirement of 19% while the delivery truck rate of return was greater than the minimum rate of return requirement of 19%. Therefore the recommendation is to invest in the delivery truck . | ||
Workings: | ||
Annual cash flows: | ||
Delivery Truck | 10540 | =(51000*0.38)-(17000*0.52) |
Bagging Machine | 7500 | =3*10*250 |
Delivery Truck | Bagging Machine | |
Present value factor | =31525.14/10540 | =31590/7500 |
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