Acct 505 Project Part 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 equipmento Payback periodo Annual rate of returno Net present valueo Internal rate of return2. 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 $93,290Year 2 inflow 2 $93,290Year 3 inflow 3 $93,290Year 4 inflow 4 $93,290Year 5 inflow 5 $133,290The 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%