Question

Clark Events is considering whether to produce a component in-house or whether to purchase it from a supplier. A supplier offers to supply the component at an annual payment of $210,000 over three years (payable at the beginning of years 1, 2, and 3, respectively).

On the other hand, Clark Events can make the component in-house. Clark Events would have to invest $242,000 in depreciable assets and it will take one year to bring the asset into production because of extensive work required (so the investment must be made at the beginning of year 0). After the initial investment, annual production costs are estimated to be $150,000 over three years (payable at the beginning of years 1, 2, and 3, respectively).

The following assumptions are made (this information may or may not be of use):

Depreciation assessed at the end of years 1, 2, and 3, respectively; assets have a liquidation value of $ 70,000 at the end of year 3

Interest rate: 10%

Tax rate: 36%

Draw a timeline for the make and one for the buy decision and include ALL cash outflows and inflows. Then compute the net present value (NPV) of these flows. Then complete the table below.

IMPORTANT: When calculating, make sure to round each calculation to the closest whole number and use that number in all your calculations! Enter commas as needed (###,### or #,###).

	"Buy" Cash Outflows	NPV of "Buy" Cash Flows	"Make" Cash Outflows	"Make" Cash Inflows	NPV of "Make" Cash Outflows	NPV of "Make" Cash Inflows
Year 0			$		$
Year 1	$210,000	$190,909	$		$
Year 2	$210,000	$173,554	$	$	$	$
Year 3	$210,000	$157,776	$	$	$	$
Year 4				$		$
Sum	$630,000	$522,239	$560,080		$
What is the difference in total costs between the NPV for the Buy option and the NPV for the Make option? (Enter as #,### or ###)					$
Should the firm make or buy? (Enter Make or Buy)

Answer 1

	"Buy" Cash Ouflow	NPV of "Buy" cash flow	"Make" Cash Outflow	"Make" cash Inflow	PVF@10%	NPV of "Make" Cash Outflow	NPV of "MAke" Cash Inflowes	Remak
Year0			$242,000		1	$242,000	$0
Year1	$210,000	$190,909	$150,000	$20,640	0.91	$136,364	$18,764
Year2	$210,000	$173,554	$150,000	$20,640	0.83	$123,967	$17,058
Year3	$210,000	$157,776	$150,000	$90,640	0.75	$112,697	$68,099	70000 Salvage value of Asset
Year4								Tax saving on depreciation : (242000-7000)/3*36%
Sum	$630,000	$522,239	$560,080			$511,107
		NPV for Buy option		$522,239
		NPV for Make Option		$511,107
		Differecne		$11,132
	Firm sould go with make decision.