ACCT505 - Course Project 2: Capital Budgeting Decision (Incremental Analysis)

The Hampton Company's production department has been investigating possible ways to trim the organization's total production costs. Each unit of their product is packaged into a can, and the company currently purchases these cans from an outside supplier. One possibility to reap some savings might be for Hampton to internally make the cans within their facility instead of purchasing them from the can supplier they are currently under contract with. The equipment needed to produce the cans would cost Hampton $1,000,000, with a disposal (salvage or residual) value of $200,000, and would be able to produce 27,500,000 cans over the 5-year estimated life of this new machinery. The production department estimates that approximately 5,500,000 cans would be needed for each of the next 5 years to meet the company's anticipated production and sales levels.

To support the production of the cans within their facility, Hampton would need to hire six new employees. These six new production staff members would be full-time employees working 2,000 hours per year and earning $15.00 per hour. They would also be provided employment benefits costing Hampton an additional 15% of the wages paid to each of these new employees, and each employee is expected to incur another $2,000 in health care insurance benefits paid for annually by the company.

It's estimated that the raw materials required to support production of the cans 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 Hampton decides to purchase and install the new can production machinery in its facility. Hampton is currently paying the can supplier 50 for each can.

For the incremental cost analysis of this proposal, Hampton's minimum rate of return (hurdle rate) has been determined to be 11% by the company's CFO. The pricing for the company's products as well as number of units sold will not be affected by this decision. Ignore tax issues.

Required for this analysis:

1. Based on the above information, calculate each the following items for this proposed equipment purchase (and be sure to show your work).

• Annual cash flows (i.e., expected annual savings)
• Payback period for the proposed investment
• Net Present Value (NPV) for the proposed investment

2. Would you recommend the acceptance of this proposed investment in the can production machinery? Why or why not?