| | | ACCT505 |
| | | Part B |
| | | Capital Budgeting problem | Johnnie & Sons Paints, Inc. |
| Data: |
| | | 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 | 5,000,000 |
| | | Annual production or purchase needs | 1,000,000 |
| | | Initial training costs | 0 |
| | | Number of workers needed | 3 |
| | | Annual hours to be worked per employee | 2,300 |
| | | Earnings per hour for employees | $8.50 |
| | | Annual health benefits per employee | $1,500 |
| | | Other annual benefits per employee-% of wages | 18% |
| | | Cost of raw materials per can | $0.20 |
| | | Other variable production costs per can | $0.10 |
| | | Costs to purchase cans - per can | $0.50 |
| | | Required rate of return | 10% |
| | | Tax rate | 35% |
| | | | Make | Purchase |
| Cost to produce |
| | Annual cost of direct material: |
| | | Need of 1,000,000 cans per year | $200,000 |
| | Annual cost of direct labor for new employees: |
| | | Wages | 58,650 |
| | | Health benefits | 4,500 |
| | | Other benefits | 10,557 |
| | | Total wages and benefits | 73,707 |
| | Other variable production costs | | 100,000 |
| | Total annual production costs | | $373,707 |
| | Annual cost to purchase cans | | | $500,000 |
| Part 1 Cash flows over the life of the project |
| | | | 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 |
| Part 2 Payback Period |
| | | $200,000 / $93290 = | 2.14 | years |
| Part 3 Annual rate of return |
| | Accounting income as result of decreased costs |
| | | 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% |
| Part 4 Net Present Value |
| | | | | 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 |
| Part 5 Internal Rate of Return |
| | | 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% |
jdvyas007
sample_project_b..xls
