Munch N’ Crunch Snack Company is considering two possible investments: a delivery truck or a bagging machine

Munch N’ Crunch Snack Company is considering two possible investments: a delivery truck or a bagging machine. The delivery truck would cost $43,056 and could be used to deliver an additional 95,000 bags of pretzels per year. Each bag of pretzels can be sold for a contribution margin of $0.45. The delivery truck operating expenses, excluding depreciation, are $1.35 per mile for 24,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be $61,614. The new machine would require three fewer hours of direct labor per day. Direct labor is $18 per hour. There are 250 operating days in the year. Both the truck and the bagging machine are estimated to have seven-year lives. The minimum rate of return is 13%. However, Munch N’ Crunch has funds to invest in only one of the projects.

a. Compute the internal rate of return for each investment. Use the present value of an annuity of $1 table appearing in this chapter (Exhibit 2).

b. Provide a memo to management, with a recommendation.


Answer:

a. Delivery Truck  
 Cash received from additional delivery (95,000 bags × $0.45)……………… $42,750 
 Cash used for operating expenses (24,000 miles × $1.35)……………………   32,400 
 Net cash flow for delivery truck…………………………………………………… $10,350 
Present Value Factor for an Annuity 
of $1 for 7 Periods  = 
= 
Amount to Be Invested 
Annual Net Cash Flow 
$43,056 
$10,350 
= 4.160 
Internal Rate of Return = 15% (from text Exhibit 2 for 7 periods) 
Bagging Machine 
Direct labor savings (3 hrs./day × $18/hr. × 250 days/yr.)……………… $13,500 
Present Value Factor for an Annuity 
of $1 for 7 Periods  = 
= 
Amount to Be Invested 
Annual Net Cash Flow 
$61,614 
$13,500 
= 4.564 
Internal Rate of Return = 12% (from text Exhibit 2 for 7 periods) 
b. To: Management 
 Re: Investment Recommendation 
An internal rate of return analysis was performed for the delivery truck and 
bagging machine investments. The internal rate of return for the bagging 
machine is 12%, while the delivery truck is 15% (detailed analysis available). 
The bagging machine fails to exceed our minimum rate of return requirement of 
13%. In addition, there do not appear to be any qualitative considerations that 
would favor the bagging machine. Therefore, the recommendation is to invest in 
the delivery truck.