X Company currently buys 6,500 units of a component part each year from a suppli

Question

X Company currently buys 6,500 units of a component part each year from a supplier for $8.90 each, 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 six years, at which time it will have zero disposal value. X Company estimates that it will cost $28,300 a year to make the 6,500 units.

What is the approximate rate of return if X Company makes the part instead of buying it from the supplier?

Present Value of $1.00

Present Value of an Annuity of $1.00

Period 3% 4% 5% 6% 7% 8% 9% 10% 11% 12%    1 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 0.901 0.893    2 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826 0.812 0.797    3 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751 0.731 0.712    4 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683 0.659 0.636    5 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621 0.593 0.567    6 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564 0.535 0.507    7 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513 0.482 0.452    8 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467 0.434 0.404    9 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424 0.391 0.361    10 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386 0.352 0.322

Explanation / Answer

From the given Informaation:

           Purchase of equipment i.e. present value of outflow = $150,000

                                              Also, Life of Equipment (n) = 6 years.

                                            Annual cash outflows = $28,300

                                   Savings of annual cash outflow = 6500*8.90 = $57,850 [Opportunity cost]

               This implies   Net Cash Inflow/ savings in opportunity cost (PP)= 57850-28,300 = $ 29550

Now consider,

          Present value of Annuity = Periodic payments (PP) * PVAF (r%, n)

                         150,000 = 29,550* PVAF(r%,6)

      This implies - PVAF(r%,6) = 150,000/29,550 = 5.076

When trace this value of 5.076 in Annuity table for 6 yrs, r %= 5%

                 Therfore rate of return = 5%

Note:     PVAF = Present value Annuity factor @ r%, n years

             In the above case, At annuity tables PVAF ( 5%,6) = 5.076

            

Related Questions

Navigate

• Browse (All)
• Browse X
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.