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 purchase the anvils from a supplier?

What is the present value of the cost to manufacture the anvils internally?

Explanation / Answer

PV of cost to purchase =npv(15%,CF1---CF5) where CF1---CF5 = $250*500=125,000= $ 419,019

PV of Cost to manufacture internally = npv(15%, $100*500 for 5 years) = $ 167,608

However to manufature internally, ACME will also have to invest 245,000 in fixed assets and 30,000 in Networking capital

So Net Present Value of cost to manufacture internally = 167,608+245,000+30,000= $ 442,608

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