ACC505 Project B

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 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¢ per can 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 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 Annual cash flows over the expected life of the equipment
o Payback period 
o Annual rate of return
o Net present value
o Internal rate of return 
2. Would you recommend the acceptance of this proposal? Why or why not. Prepare a short double spaced Word paper elaborating and supporting your answer.



Cost of new equipment $200,000
Expected life of equipment in years 5
Disposal value in 5 years $40,000
Life production - number of cans 5,500,000
Annual production or purchase needs 1,100,000
Initial training costs 0
Number of workers needed 3
Annual hours to be worked per employee 2,000
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%

Make Purchase


Need of 1,000,000 cans per year $200,000

Wages 58,650
Health benefits 4,500
Other benefits 10,557
Total wages and benefits 73,707

100,000

$373,707

$500,000



Before Tax Tax After Tax
Item Amount Effect Amount
Annual cash savings $126,293 0.65 $82,090
Tax savings due to depreciation 32,000 0.35 $11,200

Total annual cash flow $93,290




$200,000 / $93290 = 2.14 years




Annual cash savings $126,293
Less Depreciation 32,000
Before tax income 94,293
Tax at 35% rate 33,003
After tax income $61,290

$61,290/$200,000 = 30.65%


Before Tax After tax 10% PV Present
Item Year Amount Tax % Amount Factor Value
Cost of machine 0 -$200,000 -$200,000 1.000 -$200,000
Cost of training 0 0 0 1.000 0
Annual cash savings 1-5 $126,293 0.65 82,090 3.791 311,205
Tax savings due to depreciation 1-5 $32,000 0.35 11,200 3.791 42,459
Disposal value 5 $40,000 40,000 0.621 24,840

Net Present Value $178,504




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
Item Year Amount
Cost of machine and training 0 $(200,000)
Year 1 inflow 1 $93,290 
Year 2 inflow 2 $93,290 
Year 3 inflow 3 $93,290 
Year 4 inflow 4 $93,290 
Year 5 inflow 5 $133,290 

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(f84..f89,.30) 39.2%