Question

Question #6:

Brando’s Carmel Apples produces and sells caramel apples. The apples are dipped by hand. The owner would like to purchase a machine that will automate the process of making the caramel apples. After researching the machines, the owner found a machine that he thought would be perfect for his company. The machine will cost $262,000. In addition, the manager projected that the new caramel apple machine will increase the company’s annual net cash inflows by $40,300. Also, he estimated that the machine will have a 12-year useful life with no salvage value.

Required:

(a) Calculate the cash payback period.

(b) Calculate the machine’s internal rate of return.

(c) Calculate the machine’s net present value using a discount rate of 10%.

(d) Assuming Brando’s Caramel Apples’ cost of capital is 10%, is the investment in this machine acceptable? Why or why not?

Answer 1

Initial Investment = $262,000
Annual Cash Flows = $40,300
Life of Project = 12 years

Answer a.

Cash Payback Period = Initial Investment / Annual Cash Flows
Cash Payback Period = $262,000 / $40,300
Cash Payback Period = 6.50 years

Answer b.

Let IRR be i%

Net Present Value = -$262,000 + $40,300/(1+i) + $40,300/(1+i)^2 + … + $40,300/(1+i)^11 + $40,300/(1+i)^12
0 = -$262,000 + $40,300/(1+i) + $40,300/(1+i)^2 + … + $40,300/(1+i)^11 + $40,300/(1+i)^12

Using financial calculator, i = 10.97%

Internal Rate of Return = 10.97%

Answer c.

Discount Rate = 10%

Net Present Value = -$262,000 + $40,300/1.10 + $40,300/1.10^2 + … + $40,300/1.10^11 + $40,300/1.10^12
Net Present Value = -$262,000 + $40,300 * (1 - (1/1.10)^12) / 0.10
Net Present Value = -$262,000 + $40,300 * 6.813692
Net Present Value = $12,591.79

Answer d.

This investment in this machine is acceptable as NPV is positive and IRR is higher than discount rate.