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Leiza LMartin

AC 505 Managerial Accounting


Clark Paints

Data:
Cost of new equipment 200,000
Expected life of equipment in years 5 years
Disposal value in 5 years 40,000
Life production - number of cans 5,500,000
Annual production or purchase needs 1,100,000
Number of workers needed 3
Annual hours to be worked per employee 2000 hours
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%

Cost to produce Making Purchasing


Annual cost to purchase cans 495,000
Annual cost of direct material:
Need of 1,100,000 cans per year 275,000
Annual variable production costs per can
Other variable production costs per can 55,000
Annual cost of direct labor for new employees:
Payroll for the three employees 72,000
Annual health benefits 7,500
Other annual benefits 12,960
Total wages and benefits 92,460
Total annual production costs 422,460 495,000 (72,540)
Leiza LMartin
AC 505 Managerial Accounting

Annual cash Saving before Tax 72,540


Annual depreciation = (200000 - 40000) / 5 32,000
Tax savings due to depreciation 11,200

Cash flows over the life of the project


Before Tax Tax Effect After Tax
Item Amount (Amount )
Annual cash savings (make vs. buy) 72,540 0.65 47,151
Tax savings due to depreciation 32,000 0.35 11,200
Total annual cash flow 58,351

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
$200,000/ $58,351 = 3.4 years

Annual rate of return


Accounting income as result of decreased costs
Annual cash savings (before tax effect) 72,540
Less Depreciation (32,000)
Income before tax 40,540
Tax at 35% rate (14,189)
After tax income 26,351

Beginning investment 200,000


Annual rate return Using Beginning investment
= Income after taxes / beg investment"
$26,351/$200,000 = 13.18%
Leiza LMartin
AC 505 Managerial Accounting

Net Present Value


Before Tax After tax 12% PV Present
Item Year Amount Tax % Amount Factor Value
Cost of machine 0 (200,000) (200,000) 1 (200,000.00)
Annual cash savings 1-5 72,540 0.65 47,151 3.61 169,979.36
Tax savings due to depreciation 1-5 32,000 0.35 11,200 3.61 40,376.00
Disposal value 5 40,000 40,000 0.57 22,680.00
Net Present Value 33,035.36

Internal Rate of Return

Excel Function method to calculate IRR


Item Year Amount
Cost of machine 0 (200,000)
Year 1 inflow 1 58,351
Year 2 inflow 2 58,351
Year 3 inflow 3 58,351
Year 4 inflow 4 58,351
Year 5 inflow + 40,000 5 98,351
131,755

IRR 17.99%