Question

Community Challenges, a nonprofit organization for physically and mentally challenged people, manufactures a variety of products in four plants located in California. The company is currently purchasing an electronic igniter from an outside supplier for $31 per unit. Because of supplier reliability problems, the company is considering producing the igniters internally in a currently idle manufacturing plant. Annual volume over the next five years is expected to total 580,000 units at variable manufacturing costs of $30 per unit. Management must hire a factory supervisor and assistant for a total annual salary and fringe benefit package of $40,000.

In addition, the company must acquire $140,000 of new equipment. The equipment has a five-year service life and a $28,000 salvage value, and will be depreciated by the straight-line method. Repairs and maintenance are expected to average $14,000 per year in years 3–5, and the equipment will be sold at the end of its life.

Use the net-present-value method (total-cost approach) and a 14 percent hurdle rate to calculate the net present value of the decision to outsource and the net present value of the decision to manufacture. (Round your final answers to the nearest dollar. Negative amounts should be indicated by minus sign.)

           

2-b.	Based on the net present value calculation above, would you recommend manufacture or outsourcing.
	Manufacture Outsourcing

3.	Suppose management is able to negotiate a lower purchase price from its supplier. At what purchase price would management be financially indifferent between manufacturing and outsourcing the igniters? (Round your answer to 2 decimal places.)

Answer 1

Variable manufacturing costs = (580000*30)				17400000
Year	Variable manufacturing costs	factory supervisor and assistant	Machineray	Repairs and maintenance	Cash flow
0			$       (140,000)		$             (140,000)
1	$       (17,400,000)	$                   (40,000)			$       (17,440,000)
2	$       (17,400,000)	$                   (40,000)			$       (17,440,000)
3	$       (17,400,000)	$                   (40,000)		$       (14,000)	$       (17,454,000)
4	$       (17,400,000)	$                   (40,000)		$       (14,000)	$       (17,454,000)
5	$       (17,400,000)	$                   (40,000)	$            28,000	$       (14,000)	$       (17,426,000)

Year	Cash flow	Present Value Factor @ 14%	Present value
0	$             (140,000)	1.0000000000	$                        (140,000)
1	$       (17,440,000)	0.8771929825	$                  (15,298,246)
2	$       (17,440,000)	0.7694675285	$                  (13,419,514)
3	$       (17,454,000)	0.6749715162	$                  (11,780,953)
4	$       (17,454,000)	0.5920802774	$                  (10,334,169)
5	$       (17,426,000)	0.5193686644	$                    (9,050,518)
Net present value of the decision to manufacture			$                  (60,023,400)

Annual volume required			580,000
Multiply: Purchase cost per unit			$                               31.00
Purchase costs			$                    17,980,000
Year	Cash flow	Present Value Factor @ 14%	Present value
0		1.0000000000	$                                      -
1	$       (17,980,000)	0.8771929825	$                  (15,771,930)
2	$       (17,980,000)	0.7694675285	$                  (13,835,026)
3	$       (17,980,000)	0.6749715162	$                  (12,135,988)
4	$       (17,980,000)	0.5920802774	$                  (10,645,603)
5	$       (17,980,000)	0.5193686644	$                    (9,338,249)
Net present value of the decision to outsource			$                  (61,726,796)
Based pon the net present value calculation above, manufactrure option whould recommend.			Manufacture

Indifferent between manufacturing and outsourcing, Net present value of both option must be equal
Year	Present Value Factor @ 14%
1	0.8771929825
2	0.7694675285
3	0.6749715162
4	0.5920802774
5	0.5193686644
Total	3.4330809689
Net present value of the decision to manufacture	$          (60,023,400)
Divided by: Annuity Present value for 5 years @ 14%	3.4330809689
Annual Cash flow	(17,483,829)
Purchase costs	17,483,829
Divided by: Annual volume required	580,000
Purchase cost per unit	30.1445323
Purchase cost per unit (Rounded to 2 decimal places.)	$                       30.14

Proof of Answer

Annual volume required			580,000
Multiply: Purchase cost per unit			$                   30.1445323
Purchase costs			$                    17,483,829
Year	Cash flow	Present Value Factor @ 14%	Present value
0		1.0000000000	$                                      -
1	$       (17,483,829)	0.8771929825	$                  (15,336,692)
2	$       (17,483,829)	0.7694675285	$                  (13,453,238)
3	$       (17,483,829)	0.6749715162	$                  (11,801,086)
4	$       (17,483,829)	0.5920802774	$                  (10,351,830)
5	$       (17,483,829)	0.5193686644	$                    (9,080,553)
Net present value of the decision to outsource			$                  (60,023,400)