Data:

Cost to produce Annual cost of direct material: Annual cost of direct labor for new employees:

Total annual production costs Annual cost to purchase cans

Part 1 Cash flows over the life of the project

Part 2 Payback Period

Part 3 Annual rate of return Accounting income as result of decreased costs

Part 4 Net Present Value

Part 5 Internal Rate of Return Trial and error method to determine IRR

Cost of training Annual cash savings Tax savings due to depreciation Disposal value Net Present Value

Item Cost of machine Cost of training Annual cash savings Tax savings due to depreciation Disposal value Net Present Value Excel Function method to calculate IRR

possible IRR. The formula is: =IRR(values,guess) IRR Function

Clark Paints, Inc. Project Part B Capital Budgeting Decision

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 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

st of direct material: Need of 1,100,000 cans per year (Including Variable Cost) st of direct labor for new employees: Wages Health benefits Other benefits Total wages and benefits

ual production costs

st to purchase cans

ver the life of the project Item Annual cash savings (make vs buy) Tax savings due to depreciation Total annual cash flow

g income as result of decreased costs

Annual cash savings (before tax effect) Less Depreciation Before tax income Tax at 35% rate After tax income 39390/(150000+12000)

Item Cost of machine Cost of training Annual cash savings Tax savings due to depreciation Disposal value Net Present Value

error method to determine IRR Use higher and higher PV factors until you end up with a negative PV Here the PV factors for 24% and 28% were tried. (Be careful to use the correct PV tables - PV of $1 or PV of an annuity of $1 Then extrapolate to estimate the approximate IRR. The IRR is approximately 26% Item Cost of machine Cost of training Annual cash savings Tax savings due to depreciation Disposal value Net Present Value

Item Cost of machine Cost of training Annual cash savings Tax savings due to depreciation Disposal value Net Present Value

nction 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:

Item

Cost of machine and training Year 1 inflow Year 2 inflow Year 3 inflow Year 4 inflow Year 5 inflow The IRR function will require the range of cash flows beginning with the initial cash outflow for the investment and progressing through each year of the project. You also have to include an initial "guess" for the possible IRR. The formula is: =IRR(values,guess) IRR Function

$ $

$ $ $ $ $

200,000 5 40,000 5,500,000 1,100,000 3 2,000 12.00 2,500 18% 0.25 0.05 0.45 12%

Make

Purchase

$ $ $ $ $ $

330,000 72,000 7,500 12,960 92,460 422,460 $ 495,000

Before Tax Amount $ $

Tax Effect After Tax Amount 72,540 65.00% $ 47,151 32,000 35% $ 11,200 $ 58,351.00

* Tax effect on Annual Cash Savings is 1 - tax rate * Tax effect on Depreciation is the tax rate

(200000+12000)/61390 years

#REF!

$ $ $ $ $

72,540 (32,000) 40,540 14,189 26,351 16.27%

Year 0 0 1-5 1-5 5

Before Tax Amount Tax % $ (200,000) #REF! $ 72,540 $ 32,000 $ 40,000

After tax PV 12% Amount Factor $ (200,000) 1 #REF! 1 65% $ 47,151 3.60478 35% $ 11,200 3.60478 $ 40,000 0.5674

Present Value $ (200,000) #REF! $ 169,969 $ 40,374 $ 22,696 #REF!

r PV of an annuity of $1

Year

1-5 1-5

Before Tax Amount Tax % 0 $ (150,000) 0 $ (12,000) $ 82,600 $ 22,000 5 $ 40,000

After tax PV 30% Amount Factor $ (150,000) 1 $ (12,000) 1 0.65 $ 53,690 2.43557 0.35 $ 7,700 2.43557 $ 40,000 0.269329

Present Value $ (150,000) $ (12,000) $ 130,766 $ 18,754 $ 10,773 $ (1,707)

Year

1-5 1-5

Before Tax Amount Tax % 0 $ (150,000) 0 $ (12,000) $ 82,600 $ 22,000 5 $ 40,000

After tax PV 28% Present Amount Factor Value $ (150,000) 1 $ (150,000) $ (12,000) 1 $ (12,000) 0.65 $ 53,690 2.532 $ 135,943 0.35 $ 7,700 2.532 $ 19,496 $ 40,000 0.291038 $ 11,642 $ 5,081

Year

After Tax Amount

#VALUE! $ 58,351 $ 58,351 $ 58,351 $ 58,351 $ 98,351

#VALUE!

Cash Savings is 1 - tax rate ation is the tax rate