Question

The Elberta Fruit Farm of Ontario has always hired transient workers to pick its annual cherry crop. Francie Wright, the farm manager, has just received information on a cherry picking machine that is being purchased by many fruit farms. The machine is a motorized device that shakes the cherry tree, causing the cherries to fall onto plastic tarps that funnel the cherries into bins. Ms. Wright has gathered the following information to decide whether a cherry picker would be a profitable investment for the Elberta Fruit Farm:



a.
Currently, the farm is paying an average of $230,000 per year to transient workers to pick the cherries.

b.
The cherry picker would cost $670,000, and it would have an estimated 10-year useful life. The farm uses straight-line depreciation on all assets and considers salvage value in computing depreciation deductions. The estimated salvage value of the cherry picker is $115,000.

c.
Annual out-of-pocket costs associated with the cherry picker would be: cost of an operator and an assistant, $93,000; insurance, $2,000; fuel, $10,000; and a maintenance contract, $13,000.



Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor using tables.



Required:
1.
Determine the annual savings in cash operating costs that would be realized if the cherry picker were purchased.

Present cost of transient workers
Less out-of-pocket costs to operate the cherry picker:
Cost of an operator and assistant
Fuel
Maintenance contract
Insurance
Annual savings in cash operating costs
2a.
Compute the simple rate of return expected from the cherry picker.

Simple Rate of Return
Choose Numerator: / Choose Denominator: = Simple rate of return
Annual incremental net operating income / Initial investment = Simple rate of return
/ = %
2b.
Would the cherry picker be purchased if Elberta Fruit Farm’s required rate of return is 11%?

3a.
Compute the payback period on the cherry picker.

Payback Period
Choose Numerator: / Choose Denominator: = Payback Period
Investment required / Annual net cash inflow = Payback period
/ = years
4a.
Compute the internal rate of return promised by the cherry picker. (Round you answer to nearest whole percentage place. i.e. 0.1234 should be considered as 12%.)

Internal Rate of Return
Choose Numerator: / Choose Denominator: = Factor Number of years Internal rate of return
Investment required / Annual net cash inflow = Factor
/ =

Answer 1

Answer:

1) annual savings in cash operating costs = $112,000

Present cost of transient workers  $230,000

Cost of an operator and assistant  ($93,000)

Fuel  ($10,000)

Maintenance contract  ($13,000)

Insurance  ($2,000)

Annual savings in cash operating costs $112,000

2) a. simple rate of return = $112,000 / $670,000 = 16.72%

b. I used an excel spreadsheet to calculate the NPV with CF1 - CF9 = $112,000, and CF10 = $227,000 (includes salvage value), and a discount rate of 11%. NPV = $30,095. Since the NPV is positive, then the cherry picker should be purchased.

3) payback period = $670,000 / $112,000 =  5.98 years

4) using an excel spreadsheet the IRR = 11.99%