Corse Project B (Acct 505)

ACCT505

Part B

Capital Budgeting problem Clark Paints, Inc.

Data:

Cost of new equipment $200,000

Expected life of equipment in years 5

Disposal value in 5 years $40,000

Life production - number of cans 5,500,000

Annual production or purchase needs 1,100,000

Initial training costs 0

Number of workers needed 3

Annual hours to be worked per employee 2,000

Earnings per hour for employees $12.00

Annual health benefits per employee $2,500

Other annual benefits per employee-% of wages 18%

Cost of raw materials per can $0.25

Other variable production costs per can $0.05

Costs to purchase cans - per can $0.45

Required rate of return 12%

Tax rate 35%

Make Purchase

Cost to produce

Annual cost of direct material:

Need of 1,100,000 cans per year: $275,000

Annual cost of direct labor for new employees:

Wages: 72,000

Health benefits line: 7,500

Other benefits: 12,960

Total wages and benefits 92,460

Other variable production costs: 55,000

Total annual production costs: $422,460

Annual cost to purchase cans: $495,000

Part 1 Cash flows over the life of the project

Before Tax Tax After Tax

Item Amount Effect Amount

Annual cash savings $72,540 0.65 $47,151

Tax savings due to depreciation 32,000 0.35 $11,200

Total annual cash flow $58,351

Part 2 Payback Period

2.74 years

Part 3 Annual rate of return

Accounting income as result of decreased costs

Annual cash savings $72,540

Less Depreciation 32,000

Before tax income 40,540

Tax at 35% rate 14,189

After tax income $26,351...