AC505 - Capital Budgeting Problem 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 Cost to produce Annual cost of direct material: Need of 1,000,000 cans per year Annual cost of direct labor for new employees: Wages Health benefits Other benefits Total wages and benefits Total annual production costs Annual cost to purchase cans Part 1 Cash flows over the life of the project Item Annual cash savings (make vs buy) Tax savings due to depreciation Total annual cash flow Part 2 Payback Period ($200,000 + $0)/ $58,351 = Part 3 Annual rate of return Accounting income as result of decreased costs Annual cash savings (before tax effect) Less Depreciation Before tax income Tax at 35% rate After tax income $26,351/($200,000 + $0) = Part 4 Net Present Value 3.4 years Before Tax Tax Effect After Tax Amount Amount $72,540 0.65 $47,151 $32,000 0.35 $11,200 $58,351.00 * Tax effect on Annual Cash Savings is 1 - tax rate * Tax effect on Depreciation is the tax rate $330,000 $72,000 $7,500 $12,960 $92,460 $422,460 $495,000 $200,000 5 $40,000 5,500,000 1,100,000 3 2000 $12.00 $2,500 18% $0.25 $0.05 $0.45 12% 35% Purchase

72540 -32000 40,540 -14,189 26351 13.18%

Item 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

Year 1-5 1-5

Before Tax Amount Tax % 0 $(200,000) 0 $$72,540 $32,000 5 $40,000

After tax 10% PV Present Amount