Question

A domestic producer of baby carriages, Pramble, buys the wheels from a company in the north of England. Currently the wheels cost $4 each, but for a number of reasons the price will double. In order to produce the wheels themselves, Pramble would have to add to existing facilities at a cost of $800,000. It estimates that its unit cost of production would be $3.50. At the current time, the company sells 10,000 carriages annually. (Assume there are four wheels per carriage.)

a. At the current sales rate, how long would it take to pay back the investment for the required expansion?

b. If sales are expected to increase at a rate of 15% per year, how long will it take to pay back the expansion?

Answer 1

It would not be financially viable for Pramble to invest in expanding their facilities to produce the wheels in-house, considering the current sales rate and additional production costs.

Step-by-step explanation:

To calculate the payback period for the required expansion, we need to consider the additional cost of producing the wheels in-house and compare it with the cost of purchasing them from the supplier.

Currently, the wheels cost $4 each, and the unit cost of production for Pramble would be $3.50.

Therefore, the additional cost per wheel by producing it in-house would be $3.50 - $4 = -$0.50.

Using the current sales rate of 10,000 carriages annually, which require four wheels each, Pramble would need to produce 40,000 wheels. The total investment required for the expansion is $800,000.

Therefore, the time needed to pay back the investment would be $800,000 / (-$0.50) = -1,600,000 units of wheels.

Since negative values in this context are not meaningful, we can conclude that it would not be financially viable to invest in expanding their facilities to produce the wheels in-house.