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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 …show more content…

(Be careful to use the correct PV tables - PV of $1 or PV of an annuity of $1 Then extrapolate to estimate the approximate IRR. The IRR is approximately 33.5% Before Tax After tax 32% PV Present Item Year Amount Tax % Amount Factor Value Cost of machine 0 $(200,000) $(200,000) 1 $(200,000) Cost of training 0 $$1 $Annual cash savings 1-5 $72,540 0.65 $47,151 2.35 $110,579 Tax savings due to depreciation 1-5 $32,000 0.35 $11,200 2.35 $26,266 Disposal value 5 $40,000 $40,000 0.25 $9,980 Net Present Value Item Cost of machine Cost of training Annual cash savings Tax savings due to depreciation Disposal value Net Present Value Excel Function method to calculate IRR This function REQUIRES that you have only one cash flow per period (period 0 through period 5 for our example) This means that no annuity figures can be used. The chart for our example can be revised as follows: Item Cost of machine and training Year 1 inflow Year 2 inflow Year 3 inflow Year 4 inflow Year 5 inflow Year After Tax Amount 0 $(200,000) 1 $58,351 2 $58,351 3 $58,351 4 $58,351 5 $98,351 Year 1-5 1-5 Before Tax Amount 0 $(200,000) 0 $$72,540 $32,000 5 $40,000 Tax % $(53,175) After tax 36% PV Present Amount Factor Value $(200,000) 1 $(200,000) $1 $0.65 $47,151 2.18 $102,822 0.35 $11,200 2.18 $24,424 $40,000 0.21 $8,596 $(64,158)

The IRR function will require the range of cash flows beginning with the initial cash outflow for the

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