ACCT505 Part B Capital Budgeting problem Data: Cost of new equipment Expected life of equipment in years Disposal value

in 5 years Life production - number of cans Annual production or purchase needs Initial training costs Number of workers needed Annual hours to be worked per employee Earnings per hour for employees Annual health benefits per employee Other annual benefits per employee-% of wages Cost of raw materials per can Other variable production costs per can Costs to purchase cans - per can Required rate of return Tax rate

Clark Paints, Inc.

$200,000 5 $40,000 5,500,000 1,100,000 0 3 2,000 $12.00 $2,500 18% $0.25 $0.05 $0.45 10% 35% Make Purchase

Cost to produce Annual cost of direct material: Need of 1,100,000 cans per year Annual cost of direct labor for new employees: Wages (2,000*$12/hr)*3 employees Health benefits ($2,500*3employees) Other benefits ($72,000*18%) Total wages and benefits Other variable production costs(1,100,000 cans*5cents) Total annual production costs Annual cost to purchase cans(1,100,000*45cents)

$275,000 72,000 7,500 12,960 92,460 55,000 $422,460 $495,000

Part 1 Cash flows over the life of the project Item Annual cash savings Tax savings due to depreciation Total annual cash flow Before Tax Amount $72,540 32,000 Tax Effect After Tax Amount 0.65 $47,151 0.35 $11,200 $58,351

Part 2 Payback Period $200,000 / $58,351 = 3.43 years

Part 3 Annual rate of return Accounting income as result of decreased costs Annual cash savings Less Depreciation Before tax income Tax at 35% rate ($40,540*35%) After tax income $26,351/$200,000 = Part 4 Net Present Value Item Cost of machine Cost of training Annual cash savings Tax savings due to depreciation Disposal value Net Present Value Year 0 0 1-5 1-5 5

$72,540 32,000 40,540 14,189 $26,351 13.18%

Before Tax Amount -$200,000 0 $72,540 $32,000 $40,000

Tax %

After tax 12% PV Amount Factor -$200,000 1.000 0 1.000 0.65 47,151 3.605 0.35 11,200 3.605 40,000 0.567

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 Amount $(200,000) $58,351 $58,351 $58,351 $58,351 $98,351

Item Cost of machine and training Year 1 inflow Year 2 inflow Year 3 inflow Year 4 inflow Year 5 inflow

Year 0 1 2 3 4 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)

18.0%

Present Value -$200,000 0 169,979 40,376 22,680 $33,035

period 5 for our example) ed as follows:

ow for the investment