Capital Budgeting Decision

CAPITAL BUDGETING DECISION
Clark Paints
To look into possible ways to trim total poduction costs.

Make or purchase paint cans?
Cost of new equipment
Disposal value
Life production - number of cans
Annual production or purchase needs - number of cans
Project life

$
$

200,000
40,000
5,500,000
1,100,000
5 years

Number of workers needed
Annual work-hours per employee
Earnings per hour for employees
Other annual benefits per employee - % of wages
Annual health benefits per employee

$
$

3
2,000
12
18%
2,500

Cost of raw materials per can
Other variable costs per can

$
$

0.25
0.05

Purchase cost per can
Required rate of return
Tax rate

$

0.45
12%
35%

Make
Cost to produce:
Annual cost of direct material
Need of 1,100,000 cans per year
Annual cost of direct labor for new employees:
Wages
Health benefits
Other benefits
Total wages and benefits
Other variable costs per can
Total annual production costs
Annual cost to purchase cans

Purchase

275,000
72,000
7,500
12,960
92,460
55,000
422,460
495,000

Annual cash flows over the expected life of the equipment
Before-Tax
Amount
72,540
32,000

Annual cash savings
Tax savings due to depreciation
Total annual cash flow
Payback period =

Investment required
Annual net cash inflow

$
$

=

200,000
58,351

Tax
Effect
65% $
35%
$
= 3.43 years

Annual rate of return
Accounting income as a result of decreased costs:
Annual cash savings
Les depreciation
Before-tax income
Tax at 35% rate
After-tax income
Annual rate of return =

$
$
$

After-tax income
Initial investment

$
$

=

26,351
200,000

After-Tax
Amount
47,151
11,200
58,351

72,540
32,000
40,540
14,189
26,351

= 13.18%

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

Bef-tax
Year
amount
0 (200,000)
0
0
1-5
72,540
1-5