X Company currently buys 6,500 units of a component part each year from a suppli

Question

X Company currently buys 6,500 units of a component part each year from a supplier for $8.30 each, but it is considering making the part instead. In order to make the part, X Company will have to buy equipment that will cost $150,000. The equipment will last for six years, at which time it will have zero disposal value. X Company estimates that it will cost $24,400 a year to make the 6,500 units. What is the approximate rate of return if X Company makes the part instead of buying it from the supplier?

Explanation / Answer

Fixed cost per year = 150000 / 6 = 25000

Variable cost             = 24400

Thus total cost of production = $49400

Cost of buying from supplier = 6500 x 8.30 = $53950

Thus Margin (53950 – 49400) = $4550

Per unit return = 4550 / 6500 = $0.7

Rate of Return on cost = 4550 x 100 / 49400   = 9.21 %

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