finding approximate rate of return by using present value/present value annuity
ID: 2452863 • Letter: F
Question
finding approximate rate of return by using present value/present value annuity table X Company currently buys 6,500 units of a component part each year from a supplier for $8.00 each, but it is considering making the part instead. In order to make the part, Company will have to buy equipment that will cost $150,000. The equipment will last for six years, at which time it will have zero disposal value. X Company estimates that it will cost $22,450 a year to make the 6,500 units. What is the approximate rate of return if X Compan makes the part instead of buying it from the supplier?Explanation / Answer
X Company currently buys 7,000 units of a component part each year from a supplier for $7.50 each but is considering making the part instead. X Company estimates that it will cost a total of $21,990 to make the 7,000 units. Equipment will have to be purchased for $150,000 and will last for six years, at which time it will have zero disposal value. What is the approximate rate of return if X Company makes the part instead of buying it?
Answer
The answer is 10.4%. The equipment is depreciated at $25,000 per year. Plus the cost of making it per year of $21,990 = $46,990. The cost of just buying the components are $52,500. Since we dont know what the componets are selling for, we have to use the cost savings between buy the components and making them.ourselves. That come out to 10.49%. To prove my point that we need to know the price we sell the compoents at, of they were sold for $1 each our return would be negative. If we sold them for $100 each our return would be positive. But we dont know the selling price, so we are comparing the difference between the cost of goods sold between the two options you listed.
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