Course Project B Capital BudgetingAC 505 Managerial AccountingSubmitted by:Ali, MohammadCuhavilai, TitayaJalnapurkar, Sawan Kegle, JenniferMcElroy, Lucille (Team Captain)So, JeffreyWilkes, ShynastyWoo, Kenneth

Professor Douglas Hansen

Presentation Date: August 25, 2011

Course Project B:

Required:

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

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.

1. Based on the above information and using Excel, calculate the following items for this proposed equipment purchase:

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.

Given:Cost of new equipment $ 200,000 Expected life of equipment in years 5Disposal 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 3Annual hours to be worked per employee 2000Earnings 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 PurchaseCost to produce:Annual cost of direct material:

$ 330,000 Annual cost of direct labor for new employees:

Wages $ 72,000 Health benefits $ 7,500 Other benefits $ 12,960 Total wages and benefits $ 92,460

Total annual production costs $ 422,460

Annual cost to purchase cans $ 495,000

Part 1 Cash flows over the life of the projectBefore Tax Tax Effect After Tax

Item Amount Amount

Tax effect on Annual Cash Savings is (1 - tax rate)($495,000- $422,460) $ 72,540 0.65 $ 47,151

Tax effect on Depreciation is the tax rate

Need of 1,100,000 cans per year

Annual cash savings (make vs buy)

Tax savings due to depreciation

(Cost of equipment-disposable value)/life

(500000-40000)/5 $ 32,000 0.35 $ 11,200 Total annual cash flow $ 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 Payback Period

Given: Cost of new equipment $200,000.00

$58,351.00

Payback period = Investment - Cash FlowRemaining

Yr 1 = $200,000.00 - $58,351.00 = $141,649.00Yr 2 = $141,649.00 - $58,351.00 = $83,298.00Yr 3 = $83,298.00 - $58,351.00 = $24,947.00Yr 4 = $24,947.00

Yr 3 remaining $24,947.00

$4,862.58

5.13 Answer: 3 years and 5 months

Annual Cash Flow Savings (from 1)

Monthly savings ($58351/12)

Yr 3 remaining/ monthly savings