Question

A bicycle manufacturer currently produces 221 comma 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 $ 1.40 per chain. The necessary machinery would cost $ 291 comma 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 $ 44 comma 000 of inventory and other working capital upfront​ (year 0), 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 $ 21 comma 825. If the company pays tax at a rate of 20 % 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 flows for years 1 to 10 of buying the chains is?

The NPV of buying the chains from the FCF is?

The initial FCF of producing the chains is?

The FCF in years 1 through 9 of producing the chains is

​The FCF in year 10 of producing the chains is

The NPV of producing the chains from the FCF is

The net present value of producing the chains​ in-house instead of purchasing them from the supplier is

Answer 1

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