Question

The Elberta Fruit Farm of Ontario always has hired transient workers to pick its annual cherry crop. Janessa Wright, the farm manager, just received information on a cherry picking machine that is being purchased by many fruit farms. The machine is a motorized device that shakes the cherry tree, causing the cherries to fall onto plastic tarps that funnel the cherries into bins. Ms. Wright has gathered the following information to decide whether a cherry picker would be a profitable investment for the Elberta Fruit Farm.

1. Currently, the farm is paying an average of $180,000 per year to transient workers to pick the cherries.
2. The cherry picker would cost $420,000. It would be depreciated using the straight-line method and it would have no salvage value at the end of its 10-year useful life.
3. Annual out-of-pocket costs associated with the cherry picker would be: cost of an operator and an assistant, $85,000; insurance, $2,000; fuel, $10,000; and a maintenance contract, $15,000.

Determine the annual savings in cash operating costs that would be realized if the cherry picker were purchased

	Annual savings in cash operating costs

Compute the simple rate of return expected from the cherry picker. (Round your answer to 2 decimal places.)

	Simple rate of return %

Would the cherry picker be purchased if Elberta Fruit Farm’s required rate of return is 12%? Yes or no

Compute the payback period on the cherry picker. (Round your answer to 2 decimal places.)

	Payback period years

The Elberta Fruit Farm will not purchase equipment unless it has a payback period of eight years or less. Would the cherry picker be purchased? Yes or no

Compute the internal rate of return promised by the cherry picker. (Round your answer to the nearest whole percent.)

	Internal rate of return    %

Based on this computation, does it appear that the simple rate of return is an accurate guide in investment decisions? Yes or no

Answer 1

1
Present cost of transient workers		180000
Less: Out of pocket fixed costs
Cost of an operator and assistant	85000
Insurance	2000
Fuel	10000
Maintenance contract	15000	112000
Annual savings in cash operating costs		68000
2
Annual savings in cash operating costs	68000
Less: Depreciation expense	42000	=420000/10
Annual incremental net operating income	26000
Annual incremental net operating income	26000
Divide by Investment cost	420000
Simple rate of return	6.19%
2b
NO, as simple rate of return is less than 12%
3a
Investment cost	420000
Divide by Annual savings in cash operating costs	68000
Payback period	6.18	years
3b
Yes, as payback period is less than 8 years
4a
Investment cost	420000
Divide by Annual savings in cash operating costs	68000
PV factor for internal rate of return	6.176
The PV factor 6.176 for 10 years is closest to 10%
Internal rate of return = 10%
4b
No, simple rate of return is an not accurate guide in investment decisions.