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 companys 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.

		ACCT505
		Project 2
Data:
		Cost of new equipment
		Expected life of equipment in years
		Disposal value in 5 years
		Life productionnumber 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 cansper can
		Required rate of return
		Tax rate
			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
Part 1 Cash Flows Over the Life of the Project
			Before Tax	Tax	After Tax
		Item	Amount	Effect	Amount
		Annual cash savings
		Tax savings due to depreciation
		Total after-tax annual cash flow
Part 2 Payback Period
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
Part 4 Net Present Value
				Before Tax		After Tax	10% PV	Present
		Item	Year	Amount	Tax %	Amount	Factor	Value
		Cost of machine
		Cost of training
		Annual cash savings
		Tax savings due to depreciation
		Disposal value
		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
			Year 1 inflow	1
			Year 2 inflow	2
			Year 3 inflow	3
			Year 4 inflow	4
			Year 5 inflow	5