You work for the ACME Corporation (yes, that ACME...). The Anvil Division has a

Question

You work for the ACME Corporation (yes, that ACME...). The Anvil Division has a new idea for anvils that explode when struck in a particular spot. You have been given the task of completing the financial analysis to determine whether the company should purchase the new anvils from a supplier or manufacture them internally.

This will be a 5 year project. Unit sales are expected to be 500 anvils per year for each of the next 5 years.

If ACME purchases the anvils from a supplier, they will cost $250 each.

If ACME manufactures the anvils, the anvils will cost $100 each to produce. However, going this direction will require an immediate investment of $245,000 for the appropriate machinery, and an immediate investment of $30,000 in net working capital. The machinery is expected to have a salvage value of $0 at the end of the project, and will be depreciated on the straight line basis.

ACME's tax rate is 40%. ACME leadership considers this project to be of average risk compared to other company projects. The company's WACC is 15%, and the target capital structure will be maintained/held constant for the life of this project.

What is the present value of the cost to purchase the anvils from a supplier? Round to the nearest dollar, and do not use dollar signs or commas. (For example, write "$123,456.78" as "123457".)

Explanation / Answer

The present value calculation of the cost to purchase the anvils from a supplier where unit sales are expected to be 500 anvils per year for each of the next 5 years.

Therefore saving in cost per year = 500 units * (Purchase price - manufacturing cost)

= 500 * ($250 - $100) = $75,000 per year

Let's calculate Net Present Value of the Project

The net present value (NPV) of the cost to purchase the anvils from a supplier.is -$49,501.60, as the NPV is negative therefore manufacturing is not recommended.

Year (n) Initial Investments Depreciation (D) Increase in Net Working Capital (NWC) Saving in cost [500*($250-$100)] Before taxes cash flow (BTCF) Taxable Income (BTCF - depreciation) Income taxes (Taxable Income *40%) After Tax Net Income (taxable income - taxes) Free Cash Flow = ( Net Income + depreciation) PV at 15% [PV= CF/(1+15%)^n] 0 -$245,000 -$30,000 -$275,000 -$275,000.00 1 $49,000 $75,000 $75,000 $26,000 $10,400 $15,600 $64,600 $56,173.91 2 $49,000 $75,000 $75,000 $26,000 $10,400 $15,600 $64,600 $48,846.88 3 $49,000 $75,000 $75,000 $26,000 $10,400 $15,600 $64,600 $42,475.55 4 $49,000 $75,000 $75,000 $26,000 $10,400 $15,600 $64,600 $36,935.26 5 $49,000 $30,000 $75,000 $105,000 $56,000 $22,400 $33,600 $82,600 $41,066.80 NPV (Sum of PVs) -$49,501.60

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