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Course Project B Capital Budgeting AC 505 Managerial Accounting Submitted by: Ali, Mohammad Cuhavilai, Titaya Jalnapurkar, Sawan

Kegle, Jennifer McElroy, Lucille (Team Captain) So, Jeffrey Wilkes, Shynasty Woo, Kenneth Professor Douglas Hansen Presentation Date: August 25, 2011

Course Project B:
We will begin working on Project B at the beginning of Week 7. See Syllabus/"Due Dates for Assignments & Exams" for due date information. Clark Paints: The production department has been investigating possible ways to trim total production costs. One possibility currently being examined is to make the paint cans instead of purchasing them. The equipment needed would cost $200,000, with a disposal value of $40,000, and it would be able to produce 5,500,000 cans over the life of the machinery. The production department estimates that approximately 1,100,000 cans would be needed for each of the next five years.

The company would hire three new employees. These three individuals would be full-time employees working 2,000 hours per year and earning $12.00 per hour. They would also receive the same benefits as other production employees, 18% of wages, in addition to $2,500 of health benefits.

It is estimated that the raw materials will cost 25 per can and that other variable costs would be 5 per can. Since there is currently unused space in the factory, no additional fixed costs would be incurred if this proposal is accepted.

It is expected that cans would cost 45 each if purchased from the current supplier. The company's minimum rate of return (hurdle rate) has been determined to be 12% for all new projects, and the current tax rate of 35% is anticipated to remain unchanged. The pricing for a gallon of paint, as well as the number of units sold, will not be affected by this decision. The unit-of-production depreciation method would be used if the new equipment is purchased. Required: 1. Based on the above information and using Excel, calculate the following items for this proposed equipment purchase: o o o o o Annual cash flows over the expected life of the equipment Payback period Annual rate of return Net present value Internal rate of return

2. Would you recommend the acceptance of this proposal? Why or why not? Prepare a short doublespaced Word paper elaborating and supporting your answer.

Given: 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

$ $

$ $ $ $ $

200,000 5 40,000 5,500,000 1,100,000 3 2000 12.00 2,500 18% 0.25 0.05 0.45 12% 35% Purchase

Make 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 Health benefits Other benefits Total wages and benefits Total annual production costs Annual cost to purchase cans Part 1 Cash flows over the life of the project Before Tax Tax Effect Item Amount Annual cash savings (make vs buy) Tax effect on Annual Cash Savings is (1 - tax rate) ($495,000- $422,460) $ 72,540 0.65 Tax savings due to depreciation (Cost of equipmentdisposable value)/life Tax effect on Depreciation is the tax rate (500000-40000)/5 $ 32,000 0.35 Total annual cash flow

$ $ $ $ $ $

330,000 72,000 7,500 12,960 92,460 422,460 $ 495,000

After Tax Amount


$ $

11,200 58,351

Take advantage of the proposal to invest in new equipment, make the cans because of positive annual cash flow, savings over purchasing cans from outside vendor.

Part 2 Given:

Payback Period Cost of new equipment Annual Cash Flow Savings (from 1) Investment $200,000.00 $58,351.00 - Cash Flow $200,000.00 $141,649.00 $83,298.00 $24,947.00 $24,947.00 $58,351.00 = $58,351.00 = $58,351.00 = Remaining $141,649.00 $83,298.00 $24,947.00

Payback period = Yr 1 Yr 2 Yr 3 Yr 4 Yr 3 remaining Monthly savings ($58351/12) Yr 3 remaining/ monthly savings Answer: = = = =


5.13 3 years and 5 months