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
Item Year Amount Tax % Amount Factor
Cost of machine 0 -$200,000 -$200,000 1.000
Cost of training 0 0 0 1.000
Annual cash savings 1-5 $126,293 0.65 82,090 3.791
Tax savings due to depreciation 1-5 $32,000 0.35 11,200 3.791
Disposal value 5 $40,000 40,000 0.621
Net Present Value
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%
Present
Value
-$200,000
0
311,205
42,459
24,840
$178,504
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:
The IRR function will require the range of cash flows beginning with the initial cash outflow for the investment