Question

W5,12

A bicycle manufacturer currently produces 381,000units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier at a price of $2.10 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 $1.50 per chain. The necessary machinery would cost $298,000and 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 $57,000of 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 $22,350. If the company pays tax at a rate of 35%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? Project the annual free cash flows (FCF?) of buying the chains.

The annual free cash flows for years 1 to 10 of buying the chains is $ -------. ? (Round to the nearest dollar. Enter a free cash outflow as a negative? number.)

W7.2

Assets			Liabilities and Equity
Cash	$2 comma 0622,062		Accounts payable	?$1 comma 7291,729
Accounts receivable	3 comma 6723,672		Notes payable	1 comma 0001,000
Inventory	1 comma 1031,103		Accruals	1 comma 2201,220
Total current assets	$6 comma 8376,837		Total current liabilities	?$3 comma 9493,949
Net? plant, property, and equipment	$8 comma 5008,500		?Long-term debt	?$3 comma 0003,000
Total assets	$15 comma 33715,337		Total liabilities	?$6 comma 9496,949
			Common equity	?$8 comma 3888,388
			Total liabilities and equity	?$15 comma 33715,337

Answer 1

		INITIAL CASH FLOW:
	X	Machinery	($298,000)
	Y	Inventory and other working capital	($57,000)
	Z=X+Y	Total Initial Cash Flow	($355,000)
		Annual Operating Cash flows:
	A	Annual Quantitity of chain required	381000
	B	Savings per unit for in house production	$               0.60	(2.1-1.5)
	C=A*B	Annual Savings for inhouse production	$        228,600
	D=C*0.35	Tax expenses	$          80,010
	E=C-D	After tax annual savings	$        148,590
		Depreciation tax shield:
	F=X/10	Annual Depreciation	$          29,800
	G=F*0.35	Annual Depreciation tax shield	$          10,430
	H=E+G	Total Annual Cash inflow	$        159,020
		Terminal Tax Flow:
	I	Salvage Value	$22,350
	J=I*0.35	Taxes	$7,823
	K=I-J	After tax salvage value	$14,528
	L	Release of working capital	$57,000
	M=K+L	Total terminal cash inflow	$71,528
	PV	Present value of Operating Cash inflow	$815,765	(Using excel PV function with Rate=15%,Nper=10,Pmt=-159020,FV=-71528)
	NPV=PV+Z	Net Present value of the Decision	$460,765
	AFC	Annual Free Cash flow from year 1 to 10	$91,808	(using excel PMT function with Rate=15%,Nper=10,PV=-460765)