capital budgeting decision here is project 2: hampton ... Question Capital Budge
ID: 2734842 • Letter: C
Question
capital budgeting decision here is project 2: hampton ... 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.
Explanation / Answer
Answer:1
Answer:2 I would recommend the acceptance of this proposal of having the cans be made by the factory rather than purchase them. According to the excel calculations,$331000 ($271150 after taxes) would be saved if the cans were made by the factory. There’s also the savings of $160,000 in tax as a result of depreciation. Positive cash flow of $271150 supports the decision of making cans in house.
Cost of new equipment 1000000 Disposal value 200000 Total Production for Cans 27500000 Annual production or purchase needs 5500000 Salary for Employees (6*(2000*15*1.15 + 2000) 219000 Cost of raw materials per can 30¢ Other variable production costs per can 10¢ Costs to purchase one can 50¢ Required rate of return 11.00% Tax rate 35.00% Working Note 1 Make Vs. Buy Make Buy Purchase price 2750000 Variable Cost 2200000 Employee Salary 219000 Total Cash Cost 2419000 2750000 Annual Cash Saving (Before Tax) 331000 Annual Cash Saving (After Tax) 215150 Working Note 2 Annual Depreciation = (1000000-200000)/5 = $160000 Tax Saving Due to Depreciation = 160000*.35 = 56000 Part 1 Annual cash flows over the expected life of the equipment Annual Cash Saving (Make vs. Buy ) 215150 Tax Saving Due to Depreciation 56000 Annual Cash Flow $271,150.00 Part 2 Payback period Payback period = Initial Investment/Annual Cash Saving = 1000000/271150 = 3.69 Years Part 3 Annual rate of return Annual Cash Saving (Before Tax) 331000 Less: Depriciation 160000 Income before Taxes 171000 Less: Taxes 59850 Income After Taxes 111150 Beginning Investment 1000000 Average Investment =(1000000+200000)/2 600000 Annual rate of return (Using Beg. Investment)= Income After Taxes/Beg Investment 11.12% Annual rate of return (Using Avg. Investment)
= Income After Taxes/Avg Investment 18.53% Part 4 Net present value Cash Flow Year Initial Investment Annual Saving Salvage Value Total cash Flow PV factor @ 11% Present Value 0 -1000000 -1000000 1 -$1,000,000.00 1 $271,150.00 271150 0.900900901 $244,279.28 2 $271,150.00 271150 0.811622433 $220,071.42 3 $271,150.00 271150 0.731191381 $198,262.54 4 $271,150.00 271150 0.658730974 $178,614.90 5 $271,150.00 200000 471150 0.593451328 $279,604.59 NPV $120,832.74 Part 5 IRR Year Cash Flow 0 -1000000 1 271150 2 271150 3 271150 4 271150 5 471150 IRR 15.33%
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