Barbara\'s Body Shop is considering investing in a Kaizen training class. Traini

Question

Barbara's Body Shop is considering investing in a Kaizen training class. Training the entire workforce now incurs $100,000 in expenses. Improvement ideas will generate $50,000 annual income. Implementation expenses will cost $30,000 in year 1, 25,000 in year 2, decreasing by $5,000 per year until year 5. There are NO capital costs. The effective tax rate is 37%. A. Determine the after-tax cash flow for years 0 to 5, assuming annual income is $50,000 per year. B. Determine the after-tax rate-of-return for the cash flow in part A. If the company expects a 15% MARR on all investments, should it invest in the Kaizen program? C. Find the sensitivity of IRR to annual income for the following amounts.

$60,000 - optiistic

$50,000 - most likely

$40,000- pessimistic

D. Based on the sensitivity analysis, should the company invest in the Kaizen program? Why or why not? Solve on excel

Explanation / Answer

(A) & (B)

Note: IRR is the after-tax rate of return (Internal rate of return), computed using Excel built-in function =IRR()

Since IRR is negative, it should not invest.

(C) Sensitivity Analysis

Most likely case is in part (A) & (B).

(D)

Under no circumstances should investment be made in Kaizen because even the Optimistic case (with highest annual income) will have an IRR 8% which is lower than MARR of 15%.

Year Annual Income ($) Annual Cost ($) Net Annual Income ($) Tax ($) After-Tax Cash Flow ($) A B C = A - B D = C x 0.37 E = C - D 0 -1,00,000 -1,00,000 1 50,000 30,000 20,000 7,400 12,600 2 50,000 25,000 25,000 9,250 15,750 3 50,000 20,000 30,000 11,100 18,900 4 50,000 15,000 35,000 12,950 22,050 5 50,000 10,000 40,000 14,800 25,200 IRR = -2%

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