You work for the ACME Corporation (yes, that ACME...). The Anvil Division has a

Question

You work for the ACME Corporation (yes, that ACME...). The Anvil Division has a new idea for anvils that explode when struck in a particular spot. You have been given the task of completing the financial analysis to determine whether the company should purchase the new anvils from a supplier or manufacture them internally. This will be a 5 year project. Unit sales are expected to be 500 anvils per year for each of the next 5 years. If ACME purchases the anvils from a supplier, they will cost $250 each. If ACME manufactures the anvils, the anvils will cost $100 each to produce. However, going this direction will require an immediate investment of $245,000 for the appropriate machinery, and an immediate investment of $30,000 in net working capital. The machinery is expected to have a salvage value of $0 at the end of the project, and will be depreciated on the straight line basis. ACME's tax rate is 40%. ACME leadership considers this project to be of average risk compared to other company projects. The company's WACC is 15%, and the target capital structure will be maintained/held constant for the life of this project. What is the present value of the cost to manufacture the anvils internally? Round to the nearest dollar, and do not use dollar signs or commas. (For example, write "$123,456.78" as "123457".)

Explanation / Answer

Inital Cash Outflow = Cost of Machine + Increase in Working Capital = 245000 + 30000 = 275000

Depreciation per year = 245000 / 5 = 49000

Tax shield on depreciation per year = 49000 x 40% = 19600

Total Cash Outflows per year (Excluding initial outflow) = Cost of production of anvils (net of tax benefit) - Depreciation tax shield

Or, Total Cash Outflows per year (Excluding initial outflow) = 500 x 100 x (1 - 0.40) - 19600 = 10400

Present Value of cost to manufacture the anvils internally = 275000 + 10400 x PVIFA (15%, 5)

Or, Present Value of cost to manufacture the anvils internally = 309862.413018 or 309862

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