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:

Calculate the cash payback period.

Calculate the machine’s internal rate of return.

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

       

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

Answer 1

Cash Payback Period = Initial Investment

                                           Cash Inflows per year

                                       = 262000

                                           40300

                                      = 6.5012 years = 6.5012 * 12 months = 78 months = 6years and 6 months.

Internal Rate of Return(IRR) :

( IRR is a rate at which the present value of cash outflows is equal to present value of cash inflows)

Initial Investment   = $ 262000

Present Value of cash Inflows @ 10% = 40300 * 6.8137 = $ 274592

Present Value of cash Inflows @ 12% = 40300 * 6.1944 = $ 249634

So IRR is somewhere between 10% and 12%.

So IRR = 10% + 274592-262000 * (12-10)

                             274592-249634

              = 10% +1.009 %

             = 11.009%

Machine’s Net Present Value at discount rate of 10 %

= Present Value of Cash Inflows – Present Value of Cash Outflows

= ( 40300 * 6.8137) – (262000*1)

= 274592 – 262000

= $ 12592

Investment in Machine Feasible or Not:

Since Machine’s Net Present Value at current cost of capital(10%) is positive ie present value of cash inflows is higher than present value of Cash Outflows , so the investment in Machine is acceptable.