Ac505 Capital Budgeting Prob. Essay

SAMPLE Capital Budgeting problem

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
Number of workers needed 3
Annual hours to be worked per employee 2000
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 1,000,000 cans per year $330,000
Annual cost of direct labor for new employees:
Wages $72,000
Health benefits $7,500
Other benefits $12,960
    Total wages and benefits $92,460

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 Effect After Tax
Item Amount Amount
Annual cash savings (make vs buy) $72,540 0.65 $47,151 * Tax effect on Annual Cash Savings is 1 - tax rate
Tax savings due to depreciation $32,000 0.35 $11,200 * Tax effect on Depreciation is the tax rate

Total annual cash flow $58,351.00


Part 2 Payback Period

$200,000 / $58,351 = 3.4 years


Part 3 Annual rate of return
Accounting income as result of decreased costs
Annual cash savings (before tax effect) $72,540
Less Depreciation $32,000...