DelRay Foods must purchase a new gumdrop machine. Two machines are available. Machine 7745 has a first cost of $8,000, an estimated life of 10 years, a salvage value of $1,000, and annual operating costs estimated at $0.01 per 1,000 gumdrops. Machine A37Y has a first cost of $8,000, a life of 10 years, and no salvage value. Its annual operating costs will be $260 regardless of the number of gumdrops produced. MARR is 6%/year, and 30 million gumdrops ware produced each year. Based on an internal rate of return analysis, which machine should be recommended?

I would recommend Machine 7745

Explanation:

Machine 7745

initial outlay = $8,000

operational costs per year = $300

depreciation cost per year = $700

salvage value (at year 10) = $1,000

total costs per year (1 - 9) = $1,000

total costs year 10 = $0

using an excel spreadsheet, the IRR = 2%. Since you are analyzing costs only, not incremental revenue, then you must select the project with the lowest IRR.

Machine A37Y

initial outlay = $8,000

operational costs per year = $260

depreciation cost per year = $800

total costs per year (1 - 10) = $1,060

using an excel spreadsheet, the IRR = 4%

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