Present Value Of 1 Periods 25 26 27 28 29 30 35 40 45 50 56

Sheet1present Value Of 1periods25262728293035404550556010

*

Sheet1present Value Of 1periods25262728293035404550556010

Sheet1 Present Value of $1 Periocds 25% 26% 27% 28% 29% 30% 35% 40% 45% 50% 55% 60% 1 0............................................................095 Present Value of an Annuity of $1 in Arrears $1 Periocds 25% 26% 27% 28% 29% 30% 35% 40% 45% 50% 55% 60% 1 0............................................................508

*

Paper For Above instruction

The decision to manufacture paint cans internally versus purchasing them from an external supplier involves numerous financial considerations that can significantly impact the company's profitability and strategic positioning. This analysis examines the proposed project for Johnnie & Sons Paints Inc., focusing on key financial metrics, including annual cash flows, payback period, rate of return, net present value, and internal rate of return, to determine whether the project should be accepted based on a minimum hurdle rate of 10%.

Project Overview

The company is contemplating investing in equipment costing $200,000, with an anticipated salvage value of $40,000 at the end of its useful life, which is inferred from the production capacity and equipment lifespan. The machinery would produce five million cans over its operational period, distributing an average of one million cans annually over five years. This strategic change aims to eliminate the need to purchase cans at 50 cents each, opting instead for in-house production to achieve cost savings.

Operational Cost Analysis

The production process would require three full-time employees, each working 2,300 hours annually, earning $8.50 per hour. Including benefits—18% of wages—and health benefits of $1,500 per employee, the total annual labor cost per employee is calculated as:

  • Wages: 2,300 hours x $8.50 = $19,550
  • Benefits: 18% of wages = $3,519
  • Health benefits: $1,500
  • Total per employee: $19,550 + $3,519 + $1,500 = $24,569

For three employees, total annual labor costs amount to:

$24,569 x 3 = $73,707.

The variable costs per can include raw materials costing 20 cents and other variable costs at 10 cents, totaling 30 cents per can. For one million cans annually, variable costs sum to:

1,000,000 x $0.30 = $300,000.

Adding fixed labor costs, raw material costs, and other variable expenses gives the total annual operating costs. Since no additional fixed costs are expected due to surplus factory space, total annual expenses are:

Labor costs + raw material costs + other variable costs = $73,707 + $300,000 = $373,707.

Revenue and Cost Comparisons

When buying from the supplier, the cost per can is 50 cents, leading to annual expenses of:

1,000,000 cans x $0.50 = $500,000.

This indicates a potential annual saving of:

$500,000 (purchase cost) - $373,707 (production cost) = $126,293.

Financial Calculations

1. Annual Cash Flows

The cash flows primarily include cost savings from manufacturing versus purchasing, adjusted for taxes. The annual pre-tax savings are $126,293. After accounting for a 35% tax rate, net savings are:

$126,293 x (1 - 0.35) = $81,994.45

This net annual saving is considered the incremental cash flow attributable to the project, assuming no additional working capital requirements or other cash flows.

2. Payback Period

The payback period measures the time it takes for cumulative cash flows to recover initial investment. It is calculated as:

Initial investment / Annual net cash flow = $200,000 / $81,994.45 ≈ 2.44 years.

This suggests the project will recover its initial cost in approximately 2.44 years.

3. Annual Rate of Return (ARR)

The ARR is computed as average annual profit divided by initial investment. Using net cash flows as a proxy for profit (excluding depreciation), the ARR is:

($81,994.45 / $200,000) x 100% ≈ 41%.

This exceeds the company's hurdle rate of 10%, indicating a potentially attractive investment.

4. Net Present Value (NPV)

NPV assesses the value added by the project, discounting future cash flows at the hurdle rate of 10%. Assuming the cash flows persist over five years, the present value (PV) of annuity of $81,994.45 at 10% is calculated using the present value of an annuity factor for 5 years:

PV = $81,994.45 x factor

From the present value of annuity of $1 tables (approximately 3.7908 for 5 years at 10%), the NPV is:

NPV = ($81,994.45 x 3.7908) - $200,000 ≈ $310,948 - $200,000 = $110,948

A positive NPV indicates the project adds value and should be considered for acceptance.

5. Internal Rate of Return (IRR)

The IRR is the discount rate that makes NPV zero. Based on the cash flows, interpolating between different discount rates or using financial calculators/software yields an IRR of approximately 25-30%, substantially higher than the hurdle rate of 10%, reaffirming investment viability.

Conclusion and Recommendation

The analysis reveals that manufacturing the cans in-house is financially advantageous. The payback period of approximately 2.44 years aligns with typical corporate standards, and the high internal rate of return further supports this decision. The positive NPV confirms the project's value addition to the company. Additionally, the significant margin between the IRR and the hurdle rate indicates a robust investment buffer.

Given these findings, it is recommended that Johnnie & Sons Paints Inc. proceed with the project to manufacture paint cans internally. The strategic shift not only results in cost savings but also offers the company greater control over production, quality, and supply chain dynamics.

References

  • Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice. Cengage Learning.
  • Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance. McGraw-Hill Education.
  • Damodaran, A. (2010). Applied Corporate Finance. John Wiley & Sons.
  • Graham, J. R., & Harvey, C. R. (2001). The Theory and Practice of Corporate Finance: Evidence from the Field. Journal of Financial Economics, 60(2-3), 187-243.
  • Horngren, C. T., Sundem, G. L., & Elliott, J. A. (2013). Introduction to Financial Accounting. Pearson.
  • Van Horne, J. C., & Wachowicz, J. M. (2008). Fundamentals of Financial Management. Pearson Education.
  • Block, S. B., & Hirt, G. A. (2011). Foundations of Financial Management. McGraw-Hill Education.
  • Ross, S., Westerfield, R., & Jordan, B. (2018). Essentials of Corporate Finance. McGraw-Hill Education.
  • Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management. Cengage Learning.
  • Rubin, P. H. (Ed.). (2014). The Finance of Enterprise. Irwin.

Related Assignments