ACCT505 Project 2 Sample Capital Budgeting Problem Solution This file can be used as the template for the actual project.
| ACCT505 | |||||
| Project 2 | |||||
| Sample Capital Budgeting Problem Solution | |||||
| This file can be used as the template for the actual project. | |||||
| 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 million 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 after-tax annual cash flow | $93,290 | ||||
| Part 2 Payback Period | |||||
| $200,000 / $93290 = | 2.14 | years | |||
| Part 3 Simple 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 | |||||
| Item | Year | Amount | Tax % | ||
| Cost of machine | 0 | -$200,000 | |||
| Cost of training | 0 | 0 | |||
| Annual cash savings | 1-5 | $126,293 | 0.65 | ||
| Tax savings due to depreciation | 1-5 | $32,000 | 0.35 | ||
| Disposal value | 5 | $40,000 | |||
| 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% |
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