Data: Cost of new equipment Expected life of equipment in years Salvage Value Life Production Annual production or purchase needs Number of workers needed Annual hours to be worked per employee Earnings per hour for employees Health Benefits - % of Wages Cost of Direct Materials Variable Manufacturing Overhead Costs Unit Cost to Purchase Batteries Required rate of return Таx rate Make Purchase Cost to Produce Annual cost of direct material: Need - Cost direct material for of 3,000 Batteries Annual cost of direct labor for new employees: Wages Health benefits Total wages and benefits Other variable production costs Total annual production costs Annual Cost to Purchase Batteries Part 1 Cash Flows Over the Life of the Project Before Tax Тах After Tax Item Annual cash savings Tax savings due to depreciation Amount Effect Amount Total after-tax annual cash flow Part 2 Payback Period years
Elon Motors produces electric automobiles. In recent years, they have been making all components of the cars, excluding the batteries for each vehicle. The company's leadership team has been considering the ways to reduce the cost of producing its cars. They have considered various options and believe that they could reduce the cost of each car if they produce the car batteries instead of purchasing them from their current vendor, Avari Battery Company.
Currently, the cost of each battery is $325 per unit. The company feels that they could greatly reduce the cost if the production team makes each battery. However, to produce these batteries, the company will need to purchase specialized equipment that costs $1,570,000. However, this equipment will have a useful life of 12 years and is expected to have a salvage value of $70,000 at the end of that time.
Currently, the company purchases 3,000 batteries per year, and the company expects that the production will remain the same for the coming 12-year period. To make the batteries, the company expects that they will need to purchase direct materials at a cost of $125 per battery produced. In addition, the company will need to employ three production workers to make the batteries. The workers likely work 2,080 hours per year and make $25 per hour. In addition, health benefits will amount to 20% of the workers' annual wages. In addition, variable
Because there is currently unused space in the factory, no additional fixed costs would be incurred if this proposal is accepted. The company's cost of capital (hurdle rate) has been determined to be 10% for all new projects, and the current tax rate of 30% is anticipated to remain unchanged. The pricing for the company's products as well as number of units sold will not be affected by this decision. The straight-line
Note: This post has several subparts. The first three viz.
- the cost to produce
- cash flows over the life of the project
- payback period
have been computed below.
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