Question
A moped company produces 200,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside producer.
A moped company produces 200,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside producer. The manager believes that the chains can be made in house at a potential savings of $0.40 per chain. The new machinery would cost $260,000 and the entire cost would be depreciated straight line over 10 years. The in- house production would require $26,000 of inventory and other working capital upfront (year 0), which can be recovered at the end of the 10th year. The proceeds from selling the machine after 10 years would be $20,000. The company pays a tax rate of 20%.
What are the incremental annual cash flows associated with changing the production of the chains from outsourcing to in-house?
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