| 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 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. |
| 1 |
| Depreciation = 200,000 - 40,000 x 1,100,000 |
| | 5,500,000 |
| | 32000 |
| Salary and other benefits = 2,000 x 12 + (2,000 x 12 ) x 18% + 2,500 = | | | | | | 30820 | 92460 |
| | | | Cost if machinery is purchased cans are manufactured |
| Year | Cost if purchased (@45c) | Investment cost | Depreciation | Salary and other benefits | Raw material (@25c) | Other variable costs(@5c) | Total costs | Savings in costs | Savings in costs after tax | Salvage value after tax |
| 0 | | 200,000 | | | | | 200,000 | -200,000 |
| 1 | 495,000 | | 32,000 | 30,820 | 275,000 | 55,000 | 392,820 | 102,180 | 66,417 |
| 2 | 495,000 | | 32,000 | 30,820 | 275,000 | 55,000 | 392,820 | 102,180 | 66,417 |
| 3 | 495,000 | | 32,000 | 30,820 | 275,000 | 55,000 | 392,820 | 102,180 | 66,417 |
| 4 | 495,000 | | 32,000 | 30,820 | 275,000 | 55,000 | 392,820 | 102,180 | 66,417 |
| 5 | 495,000 | | 32,000 | 30,820 | 275,000 | 55,000 | 392,820 | 102,180 | 66,417 | 26000 |
| Year | Annual cash flows | Cummulative cash flows |
| 0 | -200,000 |
| 1 | 66,417 | 66,417 |
| 2 | 66,417 | 132,834 |
| 3 | 66,417 | 199,251 |
| 4 | 66,417 | 265,668 |
| 5 | 92,417 | 358,085 |
| Average cash flows = | 71,617 |
| Payback period = 3 + (200,000-199,251) |
| | | 66,417 |
| | = | 3.011 | years |
| Annual rate of return = Average annual cash flows/Investment |
| | = 71,617/200,000 |
| | 35.81% |
| | OR |
| Annual rate of return = Average annual cash flows/Average Investment |
| | = 71,617/(162,000)/2 |
| | 71.62% |
| Net present value & Internal rate of return |
| Year | Annual cash flows | PV@12% |
| 0 | -200,000 | ($200,000.00) |
| 1 | 66,417 | $59,300.89 |
| 2 | 66,417 | $52,947.23 |
| 3 | 66,417 | $47,274.31 |
| 4 | 66,417 | $42,209.20 |
| 5 | 92,417 | $52,439.89 |
| | NPV = | $54,171.52 |
| | IRR = | 22% |
| 2 |
| The project should be accepted based on the aceept-reject rules of NPV and IRR. |
| If NPV is positive then the project should be accepted as the present value of future cash inflows are greater than the investment cost. Clark paints has a positive NPV of $54,171.52. |
| Thus the project can be accepted. Also if IRR is greater than the cost of capital the project can be project can be accepted. Clark paints has an IRR of 22% and its cost of capital is 12%. |
| Thus the project based on IRR also should be accepted. |
jcartxr0620o8
project_b-clark_paints.xls
