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One possibility currently being examined is to make the paint cans instead of purchasing them. The equipment needed would $40,000, and it would be able to produce 5,500,000 cans over the life of the machinery. The production department estimates be needed for each of the next five years. The company would hire three new employees. These three individuals would be fu year and earning $12.00 per hour. They would also receive the same benefits as other production employees, 18% of wages, estimated that the raw materials will cost 25 per can and that other variable costs would be 5 per can. Since there is curren additional fixed costs would be incurred if this proposal is accepted. It is expected that cans would cost 45 each if purchased minimum rate of return (hurdle rate) has been determined to be 12% for all new projects, and the current tax rate of 35% is an for a gallon of paint, as well as the number of units sold, will not be affected by this decision. The unit-of-production depreciati equipment is purchased. Required: 1. Based on the above information and using Excel, calculate the following items for this p cash flows over the expected life of the equipment o Payback period o Annual rate of return o Net present value o Internal rat Cost of new equipment Disposal value Total Production for Cans Annual production or purchase needs Salary for Employees (3*(2000*12*1.18 + 2500) Cost of raw materials per can Other variable production costs per can Costs to purchase one can Required rate of return Tax rate Working Note 1 Make Vs. Buy Make Purchase price Variable Cost Employee Salary Total Cash Cost Annual Cash Saving (Before Tax) Annual Cash Saving (After Tax) Working Note 2 Annual Depreciation = (200000-40000)/5 = $32000 Tax Saving Due to Depreciation = 32000*.35 = 11200 330000 92460 422460 72540 47151 495000 Buy 495000 200000 40000 5500000 1100000 92460 25 5 45 12.00% 35.00%

Part 1 Annual cash flows over the expected life of the equipment Annual Cash Saving (Make vs. Buy ) Tax Saving Due to Depreciation Annual Cash Flow Part 2 47151 11200 $58,351.00

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Payback period Payback period = Initial Investment/Annual Cash Saving = 200000/58351 = 3.43 Years Part 3 Annual rate of return Annual Cash Saving (Before Tax) Less: Depriciation Income before Taxes Less: Taxes Income After Taxes Beginning Investment Average Investment =(200000+40000)/2 Annual rate of return (Using Beg. Investment) = Income After Taxes/Beg Investment Annual rate of return (Using Avg. Investment) = Income After Taxes/Avg Investment Part 4 Net present value Year Cash Flow Initial Investment Annual Saving 0 -200000 1 58351 2 58351 3 58351 4 58351 5 58351 72540 32000 40540 14189 26351 200000 120000

13.18% 21.96%

Part 5 IRR Year Cash Flow 0 -200000 1 58351 2 58351 3 58351 4 58351 5 98351 17.99%

IRR

CONCLUSION: 1) One simplifying assumption is that all cash flows occur at the end of a period. Another is that all cash flows generated by an

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2) The payback period is the length of time for an investment to fully recover its initial cost out of the cash receipts that it gene

3) The cost of capital is a hurdle that must be cleared before an investment project will be accepted. In the case of the net pre

4) Net present value is the present value of cash inflows less the present value of the cash outflows. The net present value ca

5) The internal rate of return is the rate of return on an investment project over its life. It is computed by finding the discount ra

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g them. The equipment needed would cost $200,000, with a disposal value of The production department estimates that approximately 1,100,000 cans would s. These three individuals would be full-time employees working 2,000 hours per production employees, 18% of wages, in addition to $2,500 of health benefits. It is d be 5 per can. Since there is currently unused space in the factory, no ans would cost 45 each if purchased from the current supplier. The company's , and the current tax rate of 35% is anticipated to remain unchanged. The pricing sion. The unit-of-production depreciation method would be used if the new calculate the following items for this proposed equipment purchase: o Annual urn o Net present value o Internal rate of return

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Salvage Value Total cash Flow PV factor @ 12% Present Value -200000 1 -$200,000.00 58351 0.89 $52,099.11 58351 0.8 $46,517.06 58351 0.71 $41,533.09 58351 0.64 $37,083.12 40000 98351 0.57 $55,807.00 NPV $33,039.37

r is that all cash flows generated by an investment project are immediately reinvested at a rate of return equal to the discount rate. An outla

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st out of the cash receipts that it generates. The payback method is used as a screening tool for investment proposals. The payback metho

e accepted. In the case of the net present value method, the cost of capital is used as the discount rate. If the net present value of the proje

sh outflows. The net present value can be negative if the present value of the outflows is greater than the present value of the inflows.

s computed by finding the discount rate that results in a zero net present value for the project.

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the discount rate. An outlay that is tax deductible results in some savings in taxes. The after-tax cost of an item is the amount of the outlay

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posals. The payback method is useful when a company has cash flow problems. The payback method is also used in industries where obso

et present value of the project is positive, then the project is acceptable because its rate of return is greater than the cost of capital. In the c

nt value of the inflows.

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of an item is the amount of the outlay less the tax savings. In capital budgeting decisions, all tax-deductible cash expenses should be inclu

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d is also used in industries where obsolescence is very rapid.

eater than the cost of capital. In the case of the internal rate of return method, the cost of capital is compared to a projects internal rate of r

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uctible cash expenses should be included on an after-tax cost basis, since the after-tax amount represents the actual net cash outflow.

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ompared to a projects internal rate of return. If the projects internal rate of return is greater than the cost of capital, then the project is accep

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sents the actual net cash outflow.

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ost of capital, then the project is acceptable.

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