A pencil company currently produces 200,000 units a year. It buys pencil tops from an outside...

A pencil company currently produces 200,000 units a year. It buys pencil tops from an outside supplier at a price of $2 per top. The plant manager believes that it would be cheaper to make these tops rather than buy them. Direct production costs are estimated to be only $1.50 per top. The necessary machinery would cost $150,000. This investment could be written off for tax purposes using straight-line depreciation over 8 years with no salvage value. The plant manager estimates that the operation would require an additional working capital investment of $30,000 that is recoverable at the end of the 10 years. If the company pays tax at a rate of 35% and the cost of capital is 15%, would you support the plant manager’s proposal? Assume the machinery can last for at least 10 years and all operating cash flows occur at the end of the year.

Solutions

Expert Solution

Cash Flows and NPV

If NPV of cash flow saved from producing inhouse is positive, we should go for it

Year	0	1	2	3	4	5	6	7	8	9	10
Production	0	200000	200000	200000	200000	200000	200000	200000	200000	200000	200000
Price		2	2	2	2	2	2	2	2	2	2
Cost per unit		1.5	1.5	1.5	1.5	1.5	1.5	1.5	1.5	1.5	1.5
Savings		400000.00	400000.00	400000.00	400000.00	400000.00	400000.00	400000.00	400000.00	400000.00	400000.00
Cost		300000.00	300000.00	300000.00	300000.00	300000.00	300000.00	300000.00	300000.00	300000.00	300000.00
Depreciation		18750.00	18750.00	18750.00	18750.00	18750.00	18750.00	18750.00	18750.00
EBT		81250.00	81250.00	81250.00	81250.00	81250.00	81250.00	81250.00	81250.00	100000.00	100000.00
Tax @ 35%		28437.50	28437.50	28437.50	28437.50	28437.50	28437.50	28437.50	28437.50	35000.00	35000.00
PAT		52812.50	52812.50	52812.50	52812.50	52812.50	52812.50	52812.50	52812.50	65000.00	65000.00
Add: depreciation		18750.00	18750.00	18750.00	18750.00	18750.00	18750.00	18750.00	18750.00	0.00	0.00
Less: investment	150000.00
Less: working capital	30000.00										-30000.00
Net Cash Flow	-180000.00	71562.50	71562.50	71562.50	71562.50	71562.50	71562.50	71562.50	71562.50	65000.00	95000.00

NPV @ 15%	183083.55

Since NPV is positive, so inhouse production can be undertaken

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

A widget manufacturer currently produces 200,000 units a year. It buys widget lids from an outside...

A widget manufacturer currently produces 200,000 units a year. It buys widget lids from an outside supplier at a price of $2 a lid. The plant manager believes that it would be cheaper to make these lids rather than buy them. Direct production costs are estimated to be only $1.50 a lid. The necessary machinery would cost $150,000 and would last 10 years. This investment would be written off immediately for tax purposes. The plan manager estimates that the operation...

A gadget producer currently manufactures 300000 units per year. It buys gadgets’ lids from an outside...

A gadget producer currently manufactures 300000 units per year. It buys gadgets’ lids from an outside supplier at a price of 2,1 USD per lid. The plant manager believes that it would be cheaper to make these lids rather than buy them. Direct production costs are estimated to be only 1,6 USD a lid. The necessary machinery would cost 155000 USD and would last 10 years. This investment could be written off for tax purposes using the seven-year accelerated tax...

X Company currently buys 7,000 units of a part each year from a supplier for $8.30...

X Company currently buys 7,000 units of a part each year from a supplier for $8.30 per part, but it is considering making the part instead. In order to make the part, X Company will have to buy equipment that will cost $150,000. The equipment will last for 6 years, at which time it will have zero disposal value. X Company estimates that it will cost $29,485 a year to make all 7,000 units. What is the approximate rate of...

X Company currently buys 7,500 units of a part each year from a supplier for $7.60...

X Company currently buys 7,500 units of a part each year from a supplier for $7.60 per part, but it is considering making the part instead. In order to make the part, X Company will have to buy equipment that will cost $150,000. The equipment will last for 6 years, at which time it will have zero disposal value. X Company estimates that it will cost $28,385 a year to make all 7,500 units. What is the approximate rate of...

A bicycle manufacturer currently produces 369,000 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

A bicycle manufacturer currently produces 369,000 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 $1.60 per chain. The necessary machinery would cost $293,000 and would be obsolete after ten years. This investment could be depreciated to...

Each year, Burnt Company produces 500,000 units of a component used in vehicle stereos. An outside...

Each year, Burnt Company produces 500,000 units of a component used in vehicle stereos. An outside supplier has offered to supply the part for $1.28. The unit cost is: Direct Materials $0.76 Direct Labor 0.25 Variable Overhead 0.14 Fixed Overhead 2.33 Total Unit Cost $3.48 Part A What are the alternatives for Reinhardt Company? Part B Assume that none of the fixed cost is avoidable. List the relevant cost(s) of internal production and of external purchase. Part C Which alternative...

The Marigold Company manufactures 1,006 units of a part that could be purchased from an outside...

The Marigold Company manufactures 1,006 units of a part that could be purchased from an outside supplier for $12 each. Marigold’s costs to manufacture each part are as follows: Direct materials $2 Direct labor 3 Variable manufacturing overhead 3 Fixed manufacturing overhead 9 Total $17 All fixed overhead is unavoidable and is allocated based on direct labor. The facilities that are used to manufacture the part have no alternative uses. (a) Calculate relevant cost to make. (b) Calculate net cost...

Marriott currently buys its ice machines from a manufacturer in China. A representative from a company...

Marriott currently buys its ice machines from a manufacturer in China. A representative from a company in Vietnam is offering to sell them for 20% less than cost from the manufacturer in China. Discuss the issues that you would consider in deciding whether or not to accept this offer.

PART 1 The materials used by the Hibiscus Company Division A are currently purchased from outside...

PART 1 The materials used by the Hibiscus Company Division A are currently purchased from outside supplier at $55 per unit. Division B is able to supply Division A with 23,100 units at a variable cost of $52 per unit. The two divisions have recently negotiated a transfer price of $51 per unit for the 23,100 units. By how much will each division's income and the company's total income change as a result of this transfer? Enter an increase as...

Barnam Company currently produces and sells 12,000 units of a product that has a contribution margin...

Barnam Company currently produces and sells 12,000 units of a product that has a contribution margin of $8 per unit. The company sells the product for a sales price of $20 per unit. Fixed costs are $37,800. The company has recently invested in new technology and expects the variable cost per unit to fall to $12 per unit. The investment is expected to increase fixed costs by $20,000. After the new investment is made, how many units must be sold...

Subjects