Question

A bicycle manufacturer currently produces 300,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier for $2 per chain. The plant manager believes their direct in-house productions costs to make their own chains is $1.50 per chain. Machinery to manufacture would cost $250,000 and would be obsolete in 10 years. They would use straight-line depreciation for tax purposes to $0 and then can be sold for scrap for $20,000. Estimation from the plant manager that it would take $50,000 for inventory. Using important formulas and theories within the book, should they continue to outsource or should they manufacture their own chains? What are the pros and cons of each? What would your recommendation be?

Answer 1

They should manufacture

It has a differential cost of 1,180,000 in the course of ten year of useful life for the machine.

Also the payback period of the investment is 2 years and the project life is 10 years. Which also is a good point in favor of manufacture the product

Return on Investment 393%

CAGR 14.68%

Step-by-step explanation:

300,000 x ($2 - $1.50) = 150,000 save per year

Buy Make Difference

Machine 250,000 -250,000

Working Capital 50,000 -50,000

Total Investment 300,000 -300,000

Cost 600,000 450,000

In ten Years 6,000,000 4,500,000 1,500,000

Salvage value 20,000 20,000

Total 6,000,000 4,820,000 1,180,000

Other method:

investment of 300,000

cost saving per year 150,000

payback: 300,000/150,000 = 2 years

Return on Investment:

1,180,000/300,000 = (3 + 14/15) = 3.9333333= 393%

CAGR

compound annual growth rate:

`Investment \: (1+ r)^(time) = Return`

`300,000 \: (1+ r)^(10) = 1,180,00`

r = .1468 = 14.68%