Capital Budgeting Decision Here is Project 2: Hampton Company: The production de
ID: 2420707 • Letter: C
Question
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 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 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 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 5Explanation / Answer
Answer: Depreciation=[(1,000,000-200000)/27,500,000]*5,500,000
=160000
Salary and other benefits=(2000*15)+(2000*15)*15%+2000=36500
Payback period:
4 years+80900/359775
=4.224 years
Simple rate of return= ((1278875-1000000)/1000000)*100
=27.8875%
NPV:
Answer:b No, Project should not be accepted because NPV is negative.
Year Cost if purchased Investment cost Depreciation Salary and other benefits Raw material Other variable costs Total costs Savings in cost Saving in cost after tax Salvage value after tax 0 -1000000 -1000000 1000000 1 2750000 160000 36500 1650000 550000 2396500 353500 229775 2 2750000 160000 36500 1650000 550000 2396500 353500 229775 3 2750000 160000 36500 1650000 550000 2396500 353500 229775 4 2750000 160000 36500 1650000 550000 2396500 353500 229775 5 2750000 160000 36500 1650000 550000 2396500 353500 229775 130000Related Questions
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