Question

One of your Taiwanese suppliers has bid on a new line of molded plastic parts that is currently being assembled at your plant. The supplier has bid $0.10 per part, given a forecast you provided of 100,000 parts in year 1; 300,000 in year 2; and 400,000 in year 3. Shipping and handling of parts from the supplier’s factory is estimated at $0.01 per unit. Additional inventory handling charges should amount to $0.006 per unit. Finally, administrative costs are estimated at $30 per month.

     Although your plant is able to continue producing the part, the plant would need to invest in another molding machine, which would cost $20,000. Direct materials can be purchased for $0.04 per unit. Direct labor is estimated at $0.05 per unit for wages plus a 50 percent surcharge for benefits and, indirect labor is estimated at $0.012 per unit plus 50 percent benefits. Up-front engineering and design costs will amount to $50,000. Finally, management has insisted that overhead be allocated if the parts are made in-house at a rate of 100 percent of direct labor wage costs. The firm uses a cost of capital of 15 percent per year.

a. Calculate the difference in NPVs between the Make and Buy options. Express all costs as positive values in your calculations. It is suggested to use the NPV function in Excel. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Difference in NPV            $

Answer 1

1) Calculation of NPV if parts are made by the company

Particulars	Intial costs	Year 1	Year 2	Year 3
Purchasing cost of new machine	20,000
Design and engineering cost	50,000
Direct materials		4,000	12,000	16,000
Direct labor		7,500	22,500	30,000
In Direct labor		1,800	5,400	7,200
Over heads		7,500	22,500	30,000
Total Costs (Cash outflows)	70,000	20,800	62,400	83,200
Discount@15%	1	0.869	0.756	0.657
NPV	70,000	18,075	47,174	54,662

  

Calculation of NPV if Parts purchased from outside

Particulars	Year 1	Year 2	Year 3
Purchasing cost	10,000	30,000	40,000
Shipping and handling charges	1,000	3,000	4,000
Additional invenory charges	600	1,800	2,400
Administrative cost	360	360	360
Total Costs (Cash outflows)	11,960	35,160	46,760
Discount@15%	0.869	0.756	0.657
NPV	10,393	26,581	30,721

Present Value of cash outflow (NPV) if the parts are made by the company= $189,911

Present Value of cash outflow (NPV) if the parts are purchased from outside= $67,695

Difference in NPV =Present Value of cash outflow (NPV) if the parts are made by the company-Present Value of cash outflow (NPV) if the parts are purchased from outside

=189,911-67,696

=$1,22,216

Working Notes

Cash out flows for 3 year if parts bought from outside

Particulars	Unit price	Units	Total Price
Purchasing cost
Year 1	0.1	1,00,000	10,000
Year 2	0.1	3,00,000	30,000
Year 3	0.1	4,00,000	40,000
Shipping and handling charges
Year 1	0.01	1,00,000	1,000
Year 2	0.01	3,00,000	3,000
Year 3	0.01	4,00,000	4,000
Additional invenory charges
Year 1	0.006	1,00,000	600
Year 2	0.006	3,00,000	1,800
Year 3	0.006	4,00,000	2,400
Administrative cost		360	360
(fixed amount each 3 years)

Cash out flows for 3 year if parts made by the company

Particulars	Unit price	Units	Total Price
Purchasing cost of machine			20,000
Design and engineering cost			50,000
Direct materials
Year 1	0.04	1,00,000	4,000
Year 2	0.04	3,00,000	12,000
Year 3	0.04	4,00,000	16,000
Direct labor
Year 1	0.075	1,00,000	7,500
Year 2	0.075	3,00,000	22,500
Year 3	0.075	4,00,000	30,000
In Direct labor
Year 1	0.018	1,00,000	1,800
Year 2	0.018	3,00,000	5,400
Year 3	0.018	4,00,000	7,200
Over heads
Year 1	100% Direct labor	1,00,000	7,500
Year 2	100% Direct labor	3,00,000	22,500
Year 3	100% Direct labor	4,00,000	30,000