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    likeus2's Avatar
    likeus2 Posts: 8, Reputation: 1
    New Member
     
    #1

    Dec 12, 2013, 04:10 PM
    Capital Budgeting Decision
    Thank you so much.
    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
    Initial training costs 0
    Number of workers needed 3
    Annual hours to be worked per employee 2,000
    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 1,100,000 cans per year $275,000
    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

    Other variable production costs 55,000

    Total annual production costs $422,460

    Annual cost to purchase cans $495,000

    For the Cash flow over the life of the project section.

    Annual cash savings 72,540 (495,000-422,460) Before Tax Amount
    Tax Effect = .55 (=1-.45)
    After Tax Amount = 39,897 (72,540*.55)

    Tax savings due to depreciation
    32,000 (200,000-40,000)* 1,100,000/5,500,000
    Tax Effect =.45
    After Tax Amount 14,400 (32,000*.45)

    Total annual cash flow is now 54,297 ( I am off by 4054).
    Did I miss something? Thank you.
    pready's Avatar
    pready Posts: 3,197, Reputation: 207
    Ultra Member
     
    #2

    Dec 13, 2013, 02:44 PM
    You are correct until your annual cash savings part. You used the wrong tax rate. The tax rate is 0.35 so your tax effect is 0.65 (1-.35).

    Your tax saving due to depreciation part, your tax effect is 0.35

    Once you change your tax effects parts and recalculate your totals you should be at $58,351 total annual cash flow.

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