12-10 Elgin Restaurant Supplies is analyzing the purchase of manufacturing equipment that will cost $20,000. The annual cash inflows for the next three years will be Year Cash flow $10000 9.000 6,500 a. Determine the internal rate of return using interpolation b. With a cost of capital of 12 percent should the machine be purchased? Solution Elgin restaurant Supplies a. Step 1 average the inflows $10000 9.000 6500 $25500÷3=$8,500 Step 2 Divide the inflows by the assumed annuity in Step 1 Investment $20000 2.353 Annuity 8,500 Step 3 Go to Appendix d for the 1 st approximation. The value in Step 2(for n=3)falls between 13% and 14% Step 4 Try a first approximation of discounting back the inflows Because the inflows are biased toward the early years, we will use the higher rate of 14% S-431 CopyrightC2005 by The McGraw-Hill Companies, IncCopyright © 2005 by The McGraw-Hill Companies, Inc. S-431 12-10. Elgin Restaurant Supplies is analyzing the purchase of manufacturing equipment that will cost $20,000. The annual cash inflows for the next three years will be: Year Cash Flow 1 ....................................... $10,000 2 ....................................... 9,000 3 ....................................... 6,500 a. Determine the internal rate of return using interpolation. b. With a cost of capital of 12 percent, should the machine be purchased? Solution: Elgin Restaurant Supplies a. Step 1 Average the inflows. $10,000 9,000 6,500 $25,500 ÷ 3 = $8,500 Step 2 Divide the inflows by the assumed annuity in Step 1. 2.353 8,500 $20,000 Annuity Investment = = Step 3 Go to Appendix D for the 1st approximation. The value in Step 2 (for n = 3) falls between 13% and 14%. Step 4 Try a first approximation of discounting back the inflows. Because the inflows are biased toward the early years, we will use the higher rate of 14%