DEVRY ACCT505 course project B
Capital BudgetiCapital Budgeting Decision
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Due by Tuesday of week 8, midnight, Mountain Time
Here is Part B:
Clark Paints: The production department has been investigating possible ways to trim total production costs. One possibility currently being examined is to make the paint cans instead of purchasing them. The equipment needed would cost $200,000 with a disposal value of $40,000 and would be able to produce 5,500,000 cans over the life of the machinery. The production department estimates that approximately 1,100,000 cans would be needed for each of the next five years.
The company would hire three new employees. These three individuals would be full-time employees working 2,000 hours per year and earning $12.00 per hour. They would also receive the same benefits as other production employees, 18% of wages in addition to $2,500 of health benefits.
It is estimated that the raw materials will cost 25¢ per can and that other variable costs would be 5¢ per can. Since there is currently unused space in the factory, no additional fixed costs would be incurred if this proposal is accepted.
It is expected that cans would cost 45¢ per can if purchased from the current supplier. The company's minimum rate of return (hurdle rate) has been determined to be 12% for all new projects, and the current tax rate of 35% is anticipated to remain unchanged. The pricing for a gallon of paint as well as number of units sold will not be affected by this decision. The unit-of-production depreciation method would be used if the new equipment is purchased.
Required:
1. Based on the above information and using Excel, calculate the following items for this proposed equipment purchase:
- Annual cash flows over the expected life of the equipment
- Payback period
- Annual rate of return
- Net present value
- Internal rate of return
2. Would you recommend the acceptance of this proposal? Why or why not. Prepare a short double spaced Word paper elaborating and supporting your answer.
| ACCT505 | ||||||||||
| Part B | ||||||||||
| Capital Budgeting problem | CLARK PAINTS | |||||||||
| Data: | ||||||||||
| Cost of new equipment | $2,00,000 | |||||||||
| Expected life of equipment in years | 5 | |||||||||
| Disposal value in 5 years | $40,000 | |||||||||
| Life production - number of cans | 55,00,000 | |||||||||
| Annual production or purchase needs | 11,00,000 | |||||||||
| Initial training costs | 0 | |||||||||
| Number of workers needed | 3 | |||||||||
| Annual hours to be worked per employee | 2,000 | |||||||||
| Earnings per hour for employees | $12.00 | |||||||||
| Annual health benefits per employee | $2,500 | |||||||||
| Other annual benefits per employee-% of wages | 18% | |||||||||
| Cost of raw materials per can | $0.25 | |||||||||
| Other variable production costs per can | $0.05 | |||||||||
| Costs to purchase cans - per can | $0.45 | |||||||||
| Required rate of return | 12% | |||||||||
| Tax rate | 35% | |||||||||
| Make | Purchase | |||||||||
| Cost to produce | ||||||||||
| Annual cost of direct material: | ||||||||||
| Need of 1,000,000 cans per year | ||||||||||
| Annual cost of direct labor for new employees: | ||||||||||
| Wages | ||||||||||
| Health benefits | ||||||||||
| Other benefits | ||||||||||
| Total wages and benefits | 0 | |||||||||
| Other variable production costs | ||||||||||
| Total annual production costs | 0 | |||||||||
| Annual cost to purchase cans | ||||||||||
| Part 1 Cash flows over the life of the project | ||||||||||
| Before Tax | Tax | After Tax | ||||||||
| Item | Effect | Amount | ||||||||
| Annual cash savings | 0.65 | $0 | ||||||||
| Tax savings due to depreciation | 0.35 | $0 | ||||||||
| Total annual cash flow | $0 | |||||||||
| Part 2 Payback Period | ||||||||||
| years | ||||||||||
| Part 3 Annual rate of return | ||||||||||
| Accounting income as result of decreased costs | ||||||||||
| Annual cash savings | ||||||||||
| Less Depreciation | ||||||||||
| Before tax income | 0 | |||||||||
| Tax at 35% rate | ||||||||||
| After tax income | $0 | |||||||||
| Part 4 Net Present Value | ||||||||||
| Before Tax | After tax | 10% PV | Present | |||||||
| Item | Year | Amount | Tax % | Amount | Factor | Value | ||||
| Cost of machine | 0 | $0 | $0 | |||||||
| Cost of training | 0 | 0 | $0 | |||||||
| Annual cash savings | 1-5 | 0.65 | - | $0 | ||||||
| Tax savings due to depreciation | 1-5 | 0.35 | - | $0 | ||||||
| Disposal value | 5 | 0 | $0 | |||||||
| Net Present Value | $0 | |||||||||
| Part 5 Internal Rate of Return | ||||||||||
| Excel Function method to calculate IRR | ||||||||||
| This function REQUIRES that you have only one cash flow per period (period 0 through period 5 for our example) | ||||||||||
| This means that no annuity figures can be used. The chart for our example can be revised as follows: | ||||||||||
| After Tax | ||||||||||
| Item | Year | Amount | ||||||||
| Cost of machine and training | 0 | |||||||||
| Year 1 inflow | 1 | |||||||||
| Year 2 inflow | 2 | |||||||||
| Year 3 inflow | 3 | |||||||||
| Year 4 inflow | 4 | |||||||||
| Year 5 inflow | 5 | |||||||||
| The IRR function will require the range of cash flows beginning with the initial cash outflow for the investment | ||||||||||
| and progressing through each year of the project. You also have to include an initial "guess" for the | ||||||||||
| possible IRR. The formula is: =IRR(values,guess) | ||||||||||
| IRR Function | IRR(f84..f89,.30) | #NUM! | ||||||||
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Solution: DEVRY ACCT505 course project B