A bicycle manufacturer currently produces 220,000 units a year and expects outpu

Question

A bicycle manufacturer currently produces 220,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier at a price of $1 .80 a chain. The plant manager believes that it would be cheaper to make these chains rather than buy them. Direct in-house production costs are estimated to be only $ 1.50 per chain. The necessary machinery would cost $223,000 and would be obsolete after ten years. This investment could be depreciated to zero for tax purposes using a ten-year straight-line depreciation schedule. The plant manager estimates that the operation would require additional working capital of $37,000 but argues that this sum can be ignored since it is recoverable at the end of the ten years. Expected proceeds from scrapping the machinery after ten years are $16,725. If the company pays tax at a rate of 35% and the opportunity cost of capital is 15%, what is the net present value of the decision to produce the chains in-house instead of purchasing them from the supplier?

Explanation / Answer

Saving in cost if each chain is produced in house Cost of Sub Contracting per Chain 1.8 Less: Cost of Producing per chain 1.5 Total saving in cost per chain 0.3 No. of units to be produced per year 220000 Total Saving in costs per year 66000 Depreciation on Machine- Straight Line 10 Years Cost of Machine-Salvage Value/No. Of Useful Years=223000-16725/10 20627.5 Year Savings in Cost Tax on costs Net Saving Depreciation on Machinery Tax Saving on depreciation Total Savings(Net Savings+ Tax Savings on Depreciation) Outflow Working Capital Salvage Total Discounting Factor @15% Discounted Values 0 -223000 -37000 -260000 -260000 1 66000 23100 42900 20627.5 7219.625 50119.625 50119.63 0.86956522 43582.28 2 66000 23100 42900 20627.5 7219.625 50119.625 50119.63 0.75614367 37897.64 3 66000 23100 42900 20627.5 7219.625 50119.625 50119.63 0.65751623 32954.47 4 66000 23100 42900 20627.5 7219.625 50119.625 50119.63 0.57175325 28656.06 5 66000 23100 42900 20627.5 7219.625 50119.625 50119.63 0.49717674 24918.31 6 66000 23100 42900 20627.5 7219.625 50119.625 50119.63 0.4323276 21668.1 7 66000 23100 42900 20627.5 7219.625 50119.625 50119.63 0.37593704 18841.82 8 66000 23100 42900 20627.5 7219.625 50119.625 50119.63 0.32690177 16384.19 9 66000 23100 42900 20627.5 7219.625 50119.625 50119.63 0.28426241 14247.13 10 66000 23100 42900 20627.5 7219.625 50119.625 37000 16725 103844.6 0.24718471 25668.8 Net Present Value 4818.8 Since the Machine is Providing a Positive Cash Flow, The Chains should be Produced in House

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.