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Clark Paints: 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 $200,000 with a disposal value
of $40,000 and would be able to produce 5,500,000 cans over the life of the
machinery. The production department estimates that approximately 1,100,000
cans would be needed for each of the next five years.
The company would hire three new
employees. These three individuals would be full-time employees working 2,000
hours per year and earning $12.00 per hour. They would also receive the same
benefits as other production employees, 18% of wages in addition to $2,500 of
health benefits.
It is estimated that the raw materials
will cost 25¢ per can and that other variable costs would be 5¢ 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 45¢
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.
Required:
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 Payback period 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.
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