Make-or-Buy Decision: Company Z has contracted to supply a governmental agency with 50,000 units of a product each year for the next five years. A certain component of this product can either be manufactured by Company Z or purchased from X Corporation, which will enter into a subcontract for 50,000 units of the component each year for five years at a price of $1.50 per unit. These alternative methods of procurement are regarded as equally desirable, except for costs.

If Company Z decides to manufacture the component, it expects the following to occur: (No tax rate is needed to solve this problem because all cash flows are subject to the same tax rate.)

1. A special-purpose machine costing $30.000 per year for five years will be rented. No other equipment or working capital will be required. (These payments are deducted in the year paid, for tax purposes.)

2. The manufacturing operation will require 1.000 square feet of productive floor space. This space is available in a building owned by Company Z and will not be needed for any other purpose in the foreseeable future. The costs of maintaining this building (including repairs, utilities, taxes, and depreciation) amount to $2 per square foot of productive floor space per year.

3. Variable manufacturing costs-materials, direct labor, and so forth-are esti- mated to be 50 cents a unit.

4. Fixed factory costs other than those mentioned in l and 2 —such as supervision and so forth —are estimated at $20,000 a year.

5. Company Z uses an after-tax discount rate of 20 percent.

Required: Should Company Z make the component or buy it from X Corporation? (Ignore taxes because all cash flows are subject to the same rate.)