Question #6: Brando’s Carmel Apples produces and sells caramel apples. The apple
ID: 2335855 • Letter: Q
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?
Explanation / Answer
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.