Question

Nancy's Notions pays a delivery firm to distribute its products in the metro area. Delivery costs are $26,000 per year. Nancy can buy a used truck for $9,000 that will be adequate for the next 3 years. Operating and maintenance costs are estimated to be $21,000 per year. At the end of 3 years, the used truck will have an estimated salvage value of $4,000. Nancy's MARR is 34%/year.

a. What is this investment's internal rate of return?

Answer 1

Cash flow of year 0 of Nancy's Notions = initial investment for the purchase of truck

= -$9,000               

Cash flow of year 1 of Nancy's Notions = Amount saved on the delivery costs - operating      

                                                                    and maintenance cost of truck

= $26,000 - $21,000

= $5,000

Cash flow of year 2 of Nancy's Notions = Amount saved on the delivery costs - operating

                                                                    and maintenance cost of truck

= $26,000 - $21,000

= $5,000

Cash flow of year 3 of Nancy's Notions = Amount saved on the delivery costs - operating

                                                                    and maintenance cost of truck + Salvage value

= $26,000 - $21,000 + $5,000

                                                                               = $9,000

Rate = 34% (given)

The IRR = 43% (calculated through excel, see image attached below).