A bicycle manufacturer currently produces 356,000 units a year and expects outpu

Question

A bicycle manufacturer currently produces 356,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier at a price of $1.90 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 $1.60 per chain. The necessary machinery would cost $207,000 and would be obsolete after 10 years. This investment could be depreciated to zero for tax purposes using a 10-year straight-line depreciation schedule. The plant manager estimates that the operation would require additional working capital of $42,000 but argues that this sum can be ignored since it is recoverable at the end of the 10 years. Expected proceeds from scrapping the machinery after 10 years are $15,525. 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? The annual free cash flow of 1-10= The NPV of buying the chains from FCF= The initial FCF of producing the chains= The FCF of producing the chains years 1-9= The FCF of year 10 producing the chains= The NPV of producing the chains from FCF The net present value of producing the chains in house instead of from the supplier is =

Explanation / Answer

Details Qty/Amt $ No of chains required per year             356,000 Cost of buying per chain                  1.90 Cost of making chain in house                  1.60 Saving per chain in making                    0.30 Yearly saving from making the chain           106,800 NPV of Making the chain in House Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Initial Investment in machine         (207,000) Investment in NWC           (42,000)        42,000 Salvage          15,525 Annual saving from making            106,800       106,800      106,800       106,800           106,800       106,800          106,800    106,800        106,800     106,800 Less Depreciation            (20,700)       (20,700)      (20,700)       (20,700)           (20,700)       (20,700)          (20,700)    (20,700)        (20,700)     (20,700) Taxable Income              86,100         86,100        86,100         86,100             86,100         86,100             86,100      86,100           86,100     101,625 Tax @35%            (30,135)       (30,135)      (30,135)       (30,135)           (30,135)       (30,135)          (30,135)    (30,135)        (30,135)     (35,569) Post Tax saving              55,965         55,965        55,965         55,965             55,965         55,965             55,965      55,965           55,965        66,056 Add Back depreciation              20,700         20,700        20,700         20,700             20,700         20,700             20,700      20,700           20,700        20,700 Total Cash flow (including NWC)         (249,000)              76,665         76,665        76,665         76,665             76,665         76,665             76,665      76,665           76,665     128,756 PV factor @15%                        1                 0.870           0.756          0.658            0.572                0.497           0.432               0.376         0.327             0.284          0.247 PV of Cash flows         (249,000)              66,665         57,970        50,408         43,833             38,116         33,144             28,821      25,062           21,793        31,827 NPV = $   148,640.1 So NPV of producing the chain in house= $   148,640.1

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

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