A bicycle manufacturer Zelo Inc. currently produces 8,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier at a price of $25 a chain (starting from year one). This outsourcing does not incur any working capital or capital expenditures. 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 $20 per chain. The necessary machinery would cost $350,000 (at year 0) and would be obsolete after 10 years. This investment could be depreciated to zero for tax purposes using a 10-year straight-line depreciation schedule. The plant manager estimates that the operation would require additional working capital of $50,000 to be invested in year 0 and it is recoverable at the end of the 10 years. Assume that scrapping the machinery after 10 years has no cashflow impact. If the company pays tax at a rate of 30% and the opportunity cost of capital is 10%, what is the net present value of the decision to produce the chains in-house instead of purchasing them from the supplier? Please answer all questions below.

A bicycle manufacturer Zelo Inc. currently produces 8,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier at a price of $25 a chain (starting from year one). This outsourcing does not incur any working capital or capital expenditures. 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 $20 per chain. The necessary machinery would cost $350,000 (at year 0) and would be obsolete after 10 years. This investment could be depreciated to zero for tax purposes using a 10-year straight-line depreciation schedule. The plant manager estimates that the operation would require additional working capital of $50,000 to be invested in year 0 and it is recoverable at the end of the 10 years. Assume that scrapping the machinery after 10 years has no cashflow impact. If the company pays tax at a rate of 30% and the opportunity cost of capital is 10%, what is the net present value of the decision to produce the chains in-house instead of purchasing them from the supplier? Please answer all questions below.

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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