A widget manufacturer currently produces 300,000 units a year. It buys widget li

Question

A widget manufacturer currently produces 300,000 units a year. It buys widget lids from an outside supplier at a price of $4 a lid. The plant manager believes that it would be cheaper to make these lids rather than buy them. Direct production costs are estimated to be only $2 a lid. The necessary machinery would cost $250,000 and would last 5 years. If the company pays a tax at a rate of 35% and the opportunity cost of capital is 15%, would you support the plant manager's proposal? State clearly any additional assumptions that you need to make.

Explanation / Answer

PV of after-tax CFs over 10 years ($K):
Buy: -300 (2) (PVA10, 15% ) (1 - .35) = -$1,304.88 K

Make: -250 - 300 (1.5) (1 - .35) PVA10, 15% + 30 PV10, 15% + 250 (.35) [.1429/1.15 + .2449/1.152+

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