Question

X Company currently buys 8,000 units of a part each year from a supplier for $7.70 per part, but it is considering making the part instead. In order to make the part, X Company will have to buy equipment that will cost $150,000. The equipment will last for 6 years, at which time it will have zero disposal value. X Company estimates that it will cost $30,130 a year to make all 8,000 units.

What is the approximate rate of return if X Company makes the part instead of buying it from the supplier? [Note: 0.03 means 3%, etc.]

A: 0.03

B: 0.04

C: 0.05

D: 0.06

E: 0.07

F: 0.08

Answer 1

Annual Saving due to making = (8000*7.70) -30130
	=$31470
We need to calculate the rate at which present value of annual payment $31470 is equal to $150000
Present value = PVAIF for 6 years *Annual Saving
$150000 =PVAIF for 6 year *$31470
PVAIF for 6 years = $150000/31470
PVAIF for 6 years =		4.766444
See PVAIF table and find out in 6 year column at which interest rate the PVAIF is 4.766444 ( or near)
Its 7%
Correct Option = E.0.07