Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 74

Environmental Cost Management Myers Manufacturing, Inc., wants to build a booth for painting the boxes it makes for small transformers to be used to power neon signs. The company can chooseeither a solvent-based or a powder paint process. The following table summarizes the costs and investment required by each approach:

	Solvent Paint System	Powder Paint System
Initial investment	$400,000	$1,200,000
Unit paint cost	$0.19	$0.20
Estimated life in years	10	10
Annual units	2,000,000	2,000,000

The firm will incur additional environmental costs with the solvent paint system but not with the powder paint system. The firm estimates annual environmental costs for the solvent paint system as follows:

	Units	Unit Cost
Monthly pit cleaning	12	$1,000
Hazardous waste disposal	183	3,000
Superfund fee	18,690	0.17
Worker training	2	1,500
Insurance	1	10,000
Amortization of air-emission permit	0.2	1,000
Air-emission fee	44.6	25
Recordkeeping	0.25	45,000
Wastewater treatment	1	50,000

The firm estimates its after-tax cost of capital to be 12 percent. Either system is a 10-year property under MACRS. The firm pays a total of 40 percent in income taxes.

Required

1. What is the difference in cost in today’s dollar for the two systems?

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2. What is the most the firm is willing to pay for the powder-based system?

(Adapted from German Boer, Margaret Curtin, and Louis Hoyt, “Environmental Cost Management,” Management Accounting [September 1998], pp. 28-38.)

Step 1 of 4

EnvironmentalCost Management(60-75 minutes)

1.

Solvent System
	Present Value	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8		Year 9	Year 10	Year 11
Initial investment	$400,000
After-tax paint cost (1)		$228,000	$228,000	$228,000	$228,000	$228,000	$228,000	$228,000	$228,000		$228,000	$228,000	0
After-tax environ. costs (3)		$383,845	$383,845	$383,845	$383,845	$383,845	$383,845	$383,845	$383,845		$383,845	$383,845
Total after-tax cash costs		$611,845	$611,845	$611,845	$611,845	$611,845	$611,845	$611,845	$611,845		$611,845	$611,845
Depreciation (MACRS) (2)		?40,000	72,000	57,600	46,080	36,880	29,480	26,200	26,200		26,240	26,200	13,120
Tax saving on deprec.		?16,000	28,800	23,040	18,432	14,752	11,792	10,480	10,480		10,496	10,480	5,248
Net after-tax cash costs		?$595,845	$583,045	$588,805	$593,413	$597,093	$600,053	$601,365	$601,365		$601,349	$601,365	(5,248)
Discount factor (12%)		?0.893	0.797	0.712	0.636	0.567	0.507	0.452	0.404		0.361	0.322	0.287
Present value	3,360,365	?532,090	464,867	419,229	377,411	338,552	304,227	271,817	242,951		217,087	193,640	(1,506)
Total cost	$3,760,365
Powder System
Initial investment	$1,200,000
After-tax paint cost(4)		?$240,000	$240,000	$240,000	$240,000	$240,000	$240,000	$240,000	$240,000		$240,000	$240,000	0
Depreciation (MACRS)		?120,000	216,000	172,800	138,240	110,640	88,440	78,600	78,600		78,720	78,600	39,360
Tax saving on deprec.		?48,000	86,400	69,120	55,296	44,256	35,376	31,440	31,440		31,488	31,440	15,744
Net after-tax cash costs		?192,000	153,600	170,880	184,704	195,744	204,624	208,560	208,560		208,512	208,560	(15,744)
Discount factor (12%)		?0.893	0.797	0.712	0.636	0.567	0.507	0.452	0.404		0.361	0.322	0.287
PV	1,064,182	?171,456	122,419	121,667	117,472	110,987	103,744	94,269	84,258		75,273	67,156	(4,519)
Total cost	$2,264,182
Difference in total cost	$1,496,183

?Notes:

?(1) ?Annual after-tax paint cost, solvent system = $0.19/unit x 2,000,000 units/year x (1 – 0.40) = $228,000.