X Company currently buys 7,500 units of a component part each year from a suppli

Question

X Company currently buys 7,500 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, 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 $31,385 a year to make the 7,500 units. What is the approximate rate of return if X Company makes the part instead of buying it from the supplier?

Explanation / Answer

Let rate of return=6%

NPV=Prevsent Value Of Inflow-Present Value of Outflow

Present value of inflow=$31,385*4.9173

=$154329.46

NPV=$154329.46-$150000

=$4329.46

Let R=10%

Present Value of inflow=$31,385*4.355

=$136681.67

NPV=$136681.67-$150000

=(13318.32)

Rate of return=Lower rate+(lower rate NPV/Lower rateNPV-higer rateNPV)(Higher Rate-Lower Rate)

=6+(4329.46/4329.46+13318.32)(10-6)

=6.98130%

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