Capital Budgeting Problem

In: Business and Management

Submitted By maggs108
Words 341
Pages 2
Margaret Gibson
Managerial Accounting
April 17, 2012

Clark Paints: Purchase vs. Manufacturer Recommendation

I am recommending that the cans are made in the factory rather than purchasing the cans. This recommendation is based on the Net present value and internal rate of return calculations as well as payback period, cash flow and annual rate of return.
The net present value, based on a 12% present value factor is 33,035. The net present value is the amount over or under the required rate of return. In other words, if the money were to be invested into something else that only returned 12% then Clark Paints would make 33,035 less than if the project was executed.
The internal rate of return is 18% which is 6% higher than the hurdle rate of 12%. The internal rate of return is the rate at which the net present value is equal to 0. The internal rate of return takes into consideration the annual cash savings, the tax savings due to depreciation and the disposal value of the equipment. The annual rate of return on the investment is 13% this calculation is less indicative of whether or not an investment would be a wise decision.
The payback period of the investment is 3.43 years, which means that it will take 3.43 years for the 200,000 dollar investment in the new equipment to be paid for with the cash flow from making the cans instead of purchasing them. The expected annual cash flow for making the cans rather than purchasing them is 58,351.
In conclusion, the 2 most important calculations are the net present value and the annual rate of return in deciding whether or not the investment would be worthwhile. The expected increase in revenue for producing the cans is 33,035 when taking into consideration that the money could be invested somewhere else with a 12% rate of return. The internal rate of return is 6% higher than the hurdle rate which makes it a…...

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