AC505-Managerial Accounting Project B Clark Paint 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 $ $ 200,000 5 40,000 5,500,000 1,100,000 3 2000 12.00 2,500 18% 0.25 0.05 0.45 35% 12% Make Cost to Produce Annual cost of direct material: Need of 1,1,000,000 cans per year Annual cost of direct labor for new employees: Wages Health benefits Other benefits Total wages and benefits Other variable cost: Total annual production costs Annual cost to purchase cans Purchase

$ $ $ $ $

$ $ $ $ $ $ $

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 (make vs buy) Tax savings due to depreciation Total annual cash flow Before Tax Tax Effect Amount $ 72,540 65% $ 32,000 35% $ 104,540 After Tax Amount $ 47,151 $ 11,200 $ 58,351.00

* Tax effect on Annual Cash Savings is 1 - tax rate * Tax effect on Depreciation is the tax rate

Part 2 Payback Period ($200,000)/ $87,690 = 3.4 years

Part 3 Annual Rate of Return Accounting income as result of decreased costs Annual cash savings (before tax effect) Less Depreciation Before tax income Tax at 35% rate After tax income $82,901/$200,000 =

$ $ $ $ $

104,540 (32,000) 72,540 25,389 47,151 23.58%

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 Part 5 Internal Rate of Return Year Before Tax Amount Tax % 0 $ (200,000) 0 $ $ 72,540 $ 32,000 5 $ 40,000 After tax 12% PV Present Amount Factor Value $ (200,000) 1 $ (200,000) $ 1 $ 65% $ 47,151 3.605 $ 169,979 35% $ 11,200 3.605 $ 40,376 $ 40,000 0.567 $ 22,680 $ 33,035

1-5 1-5

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(F105:F110,0.30) 18.0%

tax rate