Wendell’s Donut Shoppe is investigating the purchase of a new $42,700
donutmaking machine. The new machine would permit the company to reduce
the amount of parttime help needed, at a cost savings of $6,400 per
year. In addition, the new machine would allow the company to produce
one new style of donut, resulting in the sale of 2,400 dozen more donuts
each year. The company realizes a contribution margin of $2.00 per
dozen donuts sold. The new machine would have a sixyear useful life.
Explanation:
1.
2.
3.
Required:  
1. 
What would be the total annual cash inflows associated with the new machine for capital budgeting purposes?

Explanation:
1.
Added contribution margin from expanded sales: 2,400 dozen × $2.00 per dozen = $4,800. 
2.
Looking in Exhibit 13B2, a factor of 3.813 falls closest to the 15% rate of return.

3.
The
cash flows will not be even over the sixyear life of the machine
because of the extra $13,000 inflow in the sixth year. Therefore, the
above approach cannot be used to compute the internal rate of return in
this situation. Using trialanderror or some other method, the internal
rate is 19%:

Now  1  2  3  4  5  6  
Purchase of machine  $ 
(42,700)
      
Reduced parttime help   $  6,400  $  6,400  $  6,400  $  6,400  $  6,400  $  6,400  
Added contribution margin   4,800  4,800  4,800  4,800  4,800  4,800  
Salvage value of machine       13,000  
              
Total cash flows (a)  (42,700)  $  11,200  $  11,200  $  11,200  $  11,200  $  11,200  $  24,200  
Discount factor (19%) (b)  1.000  0.840  0.706  0.593  0.499  0.419  0.352  
Present value (a) × (b)  $  (42,700)  $  9,408  $  7,907  $  6,642  $  5,589  $  4,693  $  8,518 
Net present value  $  0       
