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

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 $O at the end of the project, and will be depreciated on the straight line basis ACC is 15%, and the ACME's tax rate is 40% ACME leadership considers this project to be of average risk compared to other company pojects. The company's target capital structure will be maintained/held constant for the life of this project What is the present value of the cost to purchase the anvils from a supplier? Round to the nearest dollar, and do not use dollar signs or commas. (For example write "$123,456.78" as "123457" 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

Calculation of PV of Cost of Purchase - Unit sales each year 500 Purchase price per unit 250 Annual cost of purchsae (500 x250) 125000 Annuity Factor (15%, 5Years) 3.3522 PV of Cost of Purchase = (125000 x 3.3522) 419019.4 Calculation of Cost to Manufacture Unit sales each year 500 Production cost per unit 100 Total production Cost (500 x 100) 50000 Less: Depreciation Tax Shields Depreciation (245000/5) 49000 DTS (49000 x 40%) 19600 Net Production cost (50000 - 19600) 30400 Annuity Factor (15%, 5Years) 3.3522 PV of annual cost of production 101905.5 Add: Initial Investmnets Equipment cost 245000 + Net working Capital 30000 275000 376905.5 Less: PV of Net working capital (30000 x PVF(15%,5 yr) 14915.3 (Assuming Recovered after 5 yrs) Net PV of Production 361990.2 Company should manufacture internally as it will cost less then buying Please provide feedback…. Thanks in advance… :-)

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