Answer & Explanation:Here is Project 2:
Hampton Company: The production
department has been investigating possible ways to trim total production costs.
One possibility currently being examined is to make the cans instead of
purchasing them. The equipment needed would cost $1,000,000, with a disposal
value of $200,000, and would be able to produce 27,500,000 cans over the life
of the machinery. The production department estimates that approximately 5,500,000
cans would be needed for each of the next 5 years.
The company would hire six new
employees. These six individuals would be full-time employees working 2,000
hours per year and earning $15.00 per hour. They would also receive the same
benefits as other production employees, 15% of wages in addition to $2,000 of
health benefits.
It is estimated that the raw materials
will cost 30¢ per can and that other variable costs would be 10¢ per can. Because
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 50¢
each if purchased from the current supplier. The company’s minimum rate of
return (hurdle rate) has been determined to be 11% for all new projects, and
the current tax rate of 35% is anticipated to remain unchanged. The pricing for
the company’s products 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.
Annual cash flows over the
expected life of the equipment
Payback period
Simple rate of return
Net present value
Internal rate of return
The check figure for the total annual
after-tax cash flows is $271,150.
2. Would you recommend the acceptance
of this proposal? Why or why not? Prepare a short, double-spaced paper in MS Word elaborating on and supporting
your answer.
course_project_2_instructions.docx
project_2_sample_instructions.docx
project_2_sample_project_solution.xlsx
Unformatted Attachment Preview
Capital Budgeting Decision
Here is Project 2:
Hampton Company: The production department has been investigating possible ways to trim total
production costs. One possibility currently being examined is to make the cans instead of
purchasing them. The equipment needed would cost $1,000,000, with a disposal value of
$200,000, and would be able to produce 27,500,000 cans over the life of the machinery. The
production department estimates that approximately 5,500,000 cans would be needed for each of
the next 5 years.
The company would hire six new employees. These six individuals would be full-time employees
working 2,000 hours per year and earning $15.00 per hour. They would also receive the same
benefits as other production employees, 15% of wages in addition to $2,000 of health benefits.
It is estimated that the raw materials will cost 30¢ per can and that other variable costs would be
10¢ per can. Because 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 50¢ each if purchased from the current supplier. The
company’s minimum rate of return (hurdle rate) has been determined to be 11% for all new
projects, and the current tax rate of 35% is anticipated to remain unchanged. The pricing for the
company’s products as well as number of units sold will not be affected by this decision. The unitof-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
o
o
o
o
Annual cash flows over the expected life of the equipment
Payback period
Simple rate of return
Net present value
Internal rate of return
The check figure for the total annual after-tax cash flows is $271,150.
2. Would you recommend the acceptance of this proposal? Why or why not? Prepare a short,
double-spaced paper in MS Word elaborating on and supporting your answer.
Johnnie & Sons Paints Inc.
Capital Budgeting Decision
SAMPLE PROJECT
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 5,000,000 cans over the life of the machinery. The production department estimates
that approximately 1,000,000 cans would be needed for each of the next 5 years.
These three individuals would be full-time employees working 2,300 hours per year and earning
$8.50 per hour. They would also receive the same benefits as other production employees, 18%
of wages in addition to $1,500 of health benefits.
It is estimated that the raw materials will cost 20¢ per can and that other variable costs would be
10¢ per can. Because 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 50¢ each if purchased from the current supplier. The
company’s minimum rate of return (hurdle rate) has been determined to be 10% 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-ofproduction depreciation method would be used if the new equipment is purchased.
•
Based on the above information and using Excel, calculate the following items for this
proposed equipment purchase:
1. Annual cash flows over the expected life of the equipment
2. Payback period
3. Simple rate of return
4. Net present value
5. Internal rate of return
•
Would you recommend the acceptance of this proposal? Why or why not?
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
Expected life of equipment in years
Disposal value in 5 years
Life production—number of cans
Annual production or purchase needs
Initial training costs
Number of workers needed
Annual hours to be worked per employee
Earnings per hour for employees
Annual health benefits per employee
Other annual benefits per employee—% of wages
Cost of raw materials per can
Other variable production costs per can
Costs to purchase cans—per can
Required rate of return
Tax rate
$200.000
5
$40.000
5.000.000
1.000.000
0
3
2.300
$8,50
$1.500
18%
$0,20
$0,10
$0,50
10%
35%
Make
Purchase
Cost to Produce
Annual cost of direct material:
Need of 1 million cans per year
Annual cost of direct labor for new employees:
Wages
Health benefits
Other benefits
Total wages and benefits
Other variable production costs
Total annual production costs
Annual cost to purchase cans
$200.000
58.650
4.500
10.557
73.707
100.000
$373.707
$500.000
Part 1 Cash Flows Over the Life of the Project
Item
Annual cash savings
Tax savings due to depreciation
Before Tax
Amount
Tax
Effect
$126.293
32.000
After Tax
Amount
0,65
$82.090
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
Less depreciation
Before tax income
Tax at 35% rate
After tax income
$126.293
32.000
94.293
33.003
$61.290
$61,290 / $200,000 =
30,65%
Part 4 Net Present Value
Item
Cost of machine
Cost of training
Annual cash savings
Tax savings due to depreciation
Disposal value
Net Present Value
Before Tax
Amount
Year
0
0
1-5
1-5
5
Tax %
-$200.000
0
$126.293
$32.000
$40.000
After Tax
Amount
-$200.000
0
0,65
82.090
0,35
11.200
40.000
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.
Item
Cost of machine and training
Year 1 inflow
Year 2 inflow
Year 3 inflow
Year 4 inflow
Year 5 inflow
Year
0
1
2
3
4
5
After Tax
Amount
$ (200.000)
$ 93.290
$ 93.290
$ 93.290
$ 93.290
$ 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%
10% PV Present
Factor
Value
1,000
-$200.000
1,000
0
3,791
311.205
3,791
42.459
0,621
24.840
$178.504
0 through Period 5, for our example).
can be revised as follows.
ial cash outflow for the investment
an initial guess for the
…
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