X Company currently buys 6,500 units of a component part each year from a suppli
ID: 2715934 • Letter: X
Question
X Company currently buys 6,500 units of a component part each year from a supplier for $7.70 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 $20,500 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
Capital cost of the eqipment is given as $150,000
In case the equipment is used to make the 6,500 units, there will be annual savings of $29,550 (6500*7.7 - 20500).
The equipment will last for six years, at which time it will have zero disposal value.
Total savings for six years is 177,300 (6*29550) Net gain is $27,300
Therefore approximate rate of return(without time value of money) is 18.20% ((27300/150000)*100)
In case of time value of money the cash flows is as follows:
The approximate Return on Investment is 5%
Period Cash flow 0 $-150,000 1 $29,550 2 $29,550 3 $29,550 4 $29,550 5 $29,550 6 $29,550Related Questions
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