A bicycle manufacturer currently produces 331,000 units a year and expects output levels to remain steady in the future....

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FINANCE 515 - A bicycle manufacturer currently produces 331,000 units a year and expects

April 14, 2018

A bicycle manufacturer currently produces 331,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier at a price of $1.80a 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 $231,000 and would be obsolete after ten years. This investment could be depreciated to zero for tax purposes using a ten-year straight-line depreciation schedule. The plant manager estimates that the operation would require additional working capital of $23,000 but argues that this sum can be ignored since it is recoverable at the end of the ten years. Expected proceeds from scrapping the machinery after ten years are $17,325.

If the company pays tax at a rate of 35% and the opportunity 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 supplier?










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