A bicycle manufacturer currently produces 297,000 units a year and expects outpu
ID: 2730374 • Letter: A
Question
A bicycle manufacturer currently produces 297,000 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 $210,000 and would be obsolete after ten(10) years. This investment could be depreciated to zero for tax purposes using a 10-year straight-line depreciation schedule. The plant manager estimates that the operation would require additional working capital of $28,000 but argues that this sum can be ignored because it is recoverable at the end of the 10 years. Expected proceeds from scrapping the machinery after ten years are $15,750.If the company pays tax at a rate of 35% and the cost of capital is 15%,What is the net present value of the decision to produce the chains in-house instead of purchasing them from the suppliers?Project the annual free cas flows (FCF) of buying the chains. (a) The annual free cash flows for years 1 to 10 of buying the chains is $-------.(Round to the nearest dollar.Enter a free cash outflow as a negative number.) Compute the NPV of buying the chains from the FCF.The NPV of buying the chains from the FCF is $.........(Round to the neares dollar.Enter a negative NPV as a negative number.) Compute the initial FCF of producing the chains.The initial FCF of producing the chains is $---------.(Round to the nearest dollar.Enter a free cash outflow as a negative number.)Compute the FCF in years 1 through 9 of producing the chains.The FCF in year 1 through 9 of producing the chains is $------.(Round to the nearest dollar.Enter a free cash outflow as a negative number.)Compute the FCF in year 10 of producing the chains.The FCF in year 10 of producing the chains is -------.(Round to the nearest dollar.Enter a free cash outflow as a negative number.) Compute the NPV of producing the chains from the FCF.The NPV of producing the chains from the FCF is $-------.(Round to the nearest dollar.Enter a negative NPV as a negative number.) Compute the difference between the net present values found above.The net present value of producing the chains in-house instead of purchasing them from the supplier is $----------.(Round to the nearest dollar.)
Explanation / Answer
Details Qty/Amt $ No of chains required per year 297,000 Cost of buying per chain 1.90 Cost of making chain in house 1.60 Saving per chain in making 0.30 Yearly saving from making the chain 89,100 NPV of Making the chain in House Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Initial Investment in machine (210,000) Investment in NWC (28,000) 28,000 Salvage 15,750 Annual saving from making 89,100 89,100 89,100 89,100 89,100 89,100 89,100 89,100 89,100 89,100 Less Depreciation (21,000) (21,000) (21,000) (21,000) (21,000) (21,000) (21,000) (21,000) (21,000) (21,000) Taxable Income 68,100 68,100 68,100 68,100 68,100 68,100 68,100 68,100 68,100 83,850 Tax @35% (23,835) (23,835) (23,835) (23,835) (23,835) (23,835) (23,835) (23,835) (23,835) (29,348) Post Tax saving 44,265 44,265 44,265 44,265 44,265 44,265 44,265 44,265 44,265 54,503 Add Back depreciation 21,000 21,000 21,000 21,000 21,000 21,000 21,000 21,000 21,000 21,000 Total Cash flow (including NWC) (238,000) 65,265 65,265 65,265 65,265 65,265 65,265 65,265 65,265 65,265 103,503 PV factor @15% 1 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327 0.284 0.247 PV of Cash flows (238,000) 56,752 49,350 42,913 37,315 32,448 28,216 24,536 21,335 18,552 25,584 NPV = $ 99,001.7 So NPV of producing the chain in house= $ 99,001.7 a Annual cash flow from year 1 to 10 is = $ 690,892.52 NPV of making the chain= $ 99,001.66 FCF in Each year in Year 1 -9 is = $ 65,265.00 FCF in Year 10 is = $ 103,502.50 Initial cash flow = $ (238,000.00)
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