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Question: X Company currently buys 8,000 units of a part each year from a supplier for $8.90 each, but it i...

X Company currently buys 8,000 units of a 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 6 years, at which time it will have zero disposal value. X Company estimates that it will cost $41,650 a year to make the 8,000 units.

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

Explanation / Answer

Currently Company is buying 8000 units @ $8.90 each Total cost =8000*8.9 71200 Cost of making 8000 units 41650 Depreciation of Equipment =150000/6 25000 66650 Total Saving done 4550 Total Investment made to earn the above savings 150000 Approximate rate of return =total saving/total investment% =4550/150000% 3.033333 3% approximate Alternatively If we assume that Depreciation expense included in cost of making our answer will be as follow Currently Company is buying 8000 units @ $8.90 each Total cost =8000*8.9 71200 Cost of making 8000 units 41650 Total Saving done 29550 Total Investment made to earn the above savings 150000 Approximate rate of return =total saving/total investment% =29550/150000% 19.70000 19.70% approximate

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