X Company currently buys 6,500 units of a component part each year from a suppli
ID: 2452955 • Letter: X
Question
X Company currently buys 6,500 units of a component part each year from a supplier for $8.80 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 $25,730 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
cost of purchasing of unit of component:
No of units * unit price
6500 * 8.8 = 57200
Cost of Manufacturing of an Unit annually :
Cost of production + depreciation
25730 + 25000 = 50730
Calculation of depreciation = cost of machine/ estimated life = 150000/ 6 = 25000 per year
Machine will function for 6 year
cost of producing units for 6 years = 50730 *6 = 304380
cost of purchase for 6 years = 343200
saving from manufacturing a unit for 6 years = cost of purchase - cost of production
343200 - 304380 =38820
Rate of return for a period of 6 years
= 38820/ Investment in machine = (38820/ 150000)*100 = 25.88%
Rate of return if company opted for producing the unit rather burying it is 25.88%
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