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Question: Corn Doggy, Inc. produces and sells corn dogs. The corn dogs are dipped by hand. Austin Beagle, p...

Corn Doggy, Inc. produces and sells corn dogs. The corn dogs are dipped by hand. Austin Beagle, production manager, is considering purchasing a machine that will make the corn dogs. Austin has shopped for machines and found that the machine he wants will cost $215,000. In addition, Austin estimates that the new machine will increase the company's annual net cash inflows by $33,000. The machine will have a 12-year useful life and no salvage value.

Instructions

(a) Calculate the cash payback period.

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

(c) Calculate the machine's net present value assuming the cost of capital is 10%.

(d) Assuming Corn Doggy, Inc.’s cost of capital is 10%, is the investment acceptable? Why or why not?

Answer 1

Solution a:

Investment required = $215,000

Annual cash inflows = $33,000

Useful life of machine =12 years

Cash payback period = Initial investment / Annual cash inflows = $215,000 / $33,000 = 6.52 years

Solution b:

At IRR Present value of cash inflow will be equal to present value of cash outflows. Let IRR is i.

Now

$33,000 * Cumulative PV factor at i for 12 periods = $215,000

Cumulative PV factor at i for 12 periods = 6.515151

This PV Factor will fall at i = 10% and 11%

Cumulative PV Factor at 10% = 6.813692

Cumulative PV factor at 11% = 6.492356

IRR =10% + (6.813692 - 6.515151) / (6.813692 - 6.492356) = 10.93%

Solution c:

Present value of cash inflows considering cost of capital 10% = $33,000 * Cumulative PV Factor at 10% for 12 periods

= $33,000 * 6.813692 = $224,852

NPV = PV of cash inflows- Initial Investment = $224,852 - $215,000 = $9,852

Solution d:

As NPV is positive considering cost of capital 10%, therefore investment is acceptable.