Nhan Van Tran

AC 505 Managerial Accounting

Johnnie &Son Paints Inc.
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
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

$
$
$
$

$
$
$
$
$

Cost to produce

200,000
5 years
40,000
5,000,000
1,000,000
3
2300 hours
8.50
1,500
18%
0.20
0.10
0.50
10%
35%

Making
Annual cost to purchase cans
Annual cost of direct material:
Need of 1,100,000 cans per year
Annual variable production costs per can
Other variable production costs per can
Annual cost of direct labor for new employees:
Payroll for the three employees
Annual health benefits
Other annual benefits
Total wages and benefits
Total annual production costs
Advantage of making parts

Purchasing
500,000

500,000

200,000

100,000

$
$
$
$
$

58,650
4,500
10,557
73,707
373,707 $

(126,293)

Nhan Van Tran

AC 505 Managerial Accounting

Annual cash Saving before Tax

Annual depreciation = (200000 - 40000) / 5
Tax savings due to depreciation

$
$
$

126,293
32,000
11,200

$
$

Before Tax
Amount
126,293
32,000

Cash flows over the life of the project

Item
Annual cash savings (make vs. buy)
Tax savings due to depreciation
Total annual cash flow
Tax effect on Annual Cash Savings is 1 - tax rate = 1 - 0.35 = 0.65
Tax effect on Depreciation is the tax rate = 0.35
Payback Period
Initial Investment/Annual Cash Saving
$160,000/ $93,290 =

Annual rate of return

Accounting income as result of decreased costs
Annual cash savings (before tax effect)
Less Depreciation
Income before tax
Tax at 35% rate
After tax income
Beginning investment
Annual rate return Using Beginning investment
= Income after taxes / beg investment"
$61,290/$200,000 =

1.7 years

$
$
$
$
$

126,293
(32,000)
94,293
(33,003)
61,290

160,000

38.31%

Tax Effect
0.65 $
0.35 $
$

After Tax
Amount
82,090
11,200
93,290

Nhan Van Tran

AC 505 Managerial Accounting

Net Present Value

Item
Cost of machine
Annual cash savings
Tax savings due to depreciation
Disposal value
Net Present Value

Year
0
1-5
1-5
5

$
$
$
$

Before Tax
Amount
(200,000)
126,293
32,000
40,000

$
$
$
$
$
$
$

Amount
(200,000)
93,290
93,290
93,290
93,290
133,290
306,452

Internal Rate of Return

Excel Function method to calculate IRR
Item
Cost of machine
Year 1 inflow
Year 2 inflow
Year 3 inflow
Year 4 inflow
Year 5 inflow + 40,000

Year
0
1
2
3
4
5

IRR

39.23%

Tax %
$
0.65 $
0.35 $
$

After tax
Amount
(200,000)
82,090
11,200
40,000

Nhan Van Tran

AC 505 Managerial Accounting

Nhan Van Tran

AC 505 Managerial Accounting

Nhan Van Tran

AC 505 Managerial Accounting

12% PV
Factor
1
3.605
3.605
0.567

$
$
$
$
$

Present
Value
(200,000.00)
295,936.07
40,376.00
22,680.00
158,992.07