From the course: Accounting Foundations: Making Business Decisions Using IRR and NPV
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Example: Buying a doughnut machine
From the course: Accounting Foundations: Making Business Decisions Using IRR and NPV
Example: Buying a doughnut machine
- Franklin Bakery is considering the purchase of a new doughnut machine. We will use this hypothetical doughnut machine to practice computing NPV and IRR. And also to identify where there is uncertainty in the inputs to the capital budgeting analysis framework. Now this doughnut machine costs $10,000. At the end of 10 years we will be finished using the doughnut machine and we estimate that we can sell it then in the used machine market for $1,000. This new doughnut machine will reduce our cash operating costs by $700 a year. In addition, this new machine will increase our production by 15,000 doughnut a year and we make 10 cents on each doughnut we sell. So that's a $1,500 increase in cash profit each year. Finally, our risk adjusted interest rate is 16%. We've called this the hurdle rate. In the NPV analysis this is the rate we'll use to discount the future cash flows to the present. In the IRR analysis this is the…
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