Juicetronics, a maker of juice box drinks, currently produces 200,000 batches of 100 juice boxes per...

Juicetronics, a maker of juice box drinks, currently produces 200,000 batches of 100 juice boxes per year. Each juice box needs one straw and it buys the straws from another firm, Tetra Brik, for a price of $2 per batch of 100 straws. The plant manager believes it may be cheaper to make these straws than to buy them. Direct production costs are estimated to be just $1.50 per batch. The necessary machinery would cost $150,000. The machinery would be depreciated straight-line to a zero salvage value over 10 years. After ten years, the machine would be sold for $1,000. The plant manager estimates that the operation would require additional net working capital at time 0 of $30,000. This working capital will be recovered at the end of the project. The firm pays taxes at a rate of 34% and has a 15% cost of capital. Should Juicetronics make or buy the straws?

Expert Solution

Let’s calculate net present value (NPV) of the project if Juicetronics makes the straws where saving per batch is $0.5 ($2.00 - $1.50) for 200,000 batches per year

Therefore savings per year = $0.50 * 200,000 = $100,000

NPV Calculation:

Year (t)	Value of Asset	Depreciation (straight line)D : asset/10	Salvage value	Net Working Capital (NWC)	Saving per year (($2.00 -1.50)*200,000)	Before Tax cash Flow (BTCF) = ( saving + Salvage value)	Taxable Income = (BTCF - depreciation)	Income taxes = (Taxable Income *34%)	After tax cash flow (ATCF) = (BTCF - Income tax + NWC)	PV of after tax cash flow @15%= ATCF/ (1+15%)^t
0	$150,000	N/A		-$30,000			0	0	-$180,000	-$180,000
1		$15,000			$100,000	$100,000	$85,000	$28,900	$71,100	$61,826.09
2		$15,000			$100,000	$100,000	$85,000	$28,900	$71,100	$53,761.81
3		$15,000			$100,000	$100,000	$85,000	$28,900	$71,100	$46,749.40
4		$15,000			$100,000	$100,000	$85,000	$28,900	$71,100	$40,651.66
5		$15,000			$100,000	$100,000	$85,000	$28,900	$71,100	$35,349.27
6		$15,000			$100,000	$100,000	$85,000	$28,900	$71,100	$30,738.49
7		$15,000			$100,000	$100,000	$85,000	$28,900	$71,100	$26,729.12
8		$15,000			$100,000	$100,000	$85,000	$28,900	$71,100	$23,242.72
9		$15,000			$100,000	$100,000	$85,000	$28,900	$71,100	$20,211.06
10		$15,000	$1,000	$30,000	$100,000	$101,000	$86,000	$29,240	$101,760	$25,153.52
NPV (sum of PVs)										$184,413.13

As the NPV of the project is positive ($184,413.13) therefore Juicetronics should make the straws instead of buying

jeff jeffy answered 1 year ago

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