Question
A widget manufacturer currently produces 200,000 units a year. It buys widget lids from an outside supplier at a price of $2 a lid. The
A widget manufacturer currently produces 200,000 units a year. It buys widget lids from an outside supplier at a price of $2 a lid. The plant manager believes that it would be cheaper to make these lids than buy them. Direct production costs are estimated to be only $1.50 a lid. The necessary machinery would cost $150,000. It would be depreciated on a straight line basis over a ten year life to a zero salvage value. The plant manager estimates that the operation would require additional working capital of $30,000, but argues that this sum can be ignored since it is recoverable at the end of the 10 years. If the company pays tax at a rate of 34% and the opportunity cost of capital is 15%, would you support the plant manager's proposal?
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