The production department has been investigating possible ways to trim total production costs. One possibility currently being examined is to make the paint cans instead of purchasing them. The equipment needed would cost $150,000 with a disposal value of $40,000 and would be able to produce 5,000,000 cans over the life of the machinery. The production department estimates that approximately 1,000,000 cans would be needed for each of the next five years.
In addition to the purchase cost of the equipment, $12,000 would be needed to train three new employees in the production process. These three individuals would be full-time employees working 2,000 hours per year and earning $10.00 per hour. They would also receive the same benefits as other production employees, 18% of wages in addition to $2,200 of health benefits.
It is estimated that the raw materials will cost 30¢ per can and that other variable costs would be 4¢ per can. Since there is currently unused space in the factory, no additional fixed costs would be incurred if this proposal is accepted.
It is expected that cans would cost 50¢ per can if purchased from the current supplier. The company's minimum rate of return (hurdle rate) has been determined to be 12% for all new projects, and the current tax rate of 35% is anticipated to remain unchanged. The pricing for a gallon of paint as well as number of units sold will not be affected by this decision. The unit-of-production depreciation method would be used if the new equipment is purchased.
1. Based on the above information and using Excel, calculate the following items for this proposed equipment purchase:
Annual cash flows over the expected life of the equipment
Annual rate of return
Net present value
Internal rate of return
2. Would you recommend the acceptance of this proposal? Why or why not. Prepare a short double spaced Word paper elaborating and supporting your answer.
The solution explains how to prepare the cash flows for the project, calculate various metrics and make the accept / reject decision regarding the project