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 manufacturing overhead costs are estimated to be $25 per unit.

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 depreciation method would be used if the new equipment is purchased.

Elon Motors Data: Cost of new equipment $1,570,000 Expected life of equipment in years 12 Salvage Value $70,000 Life Production 36,000 Annual production or purchase needs 3,000 Number of workers needed Annual hours to be worked per employee 2,080 Earnings per hour for employees $25.00 Health Benefits - % of Wages 20% Cost of Direct Materials $125.00 Variable Manufacturing Overhead Costs $25.00 Unit Cost to Purchase Batteries $325.00 Required rate of return 10% Tax rate 30% Make Purchase Cost to Produce Annual cost of direct material: $375,000 Need - Cost direct material for of 2,500 Batteries $312,500 Annual cost of direct labor for new employees: Wages 156,000 Health benefits 31,200 Total wages and benefits 187,200 Other variable production costs 75,000 Total annual production costs $637,200 Annual Cost to Purchase Batteries $975,000 Part 1 Cash Flows Over the Life of the Project Before Tax Tax After Tax Item Amount Effect Amount Annual cash savings $337,800 101,340 $236,460 Tax savings due to depreciation 125,000 37,500 $87,500 Total after-tax annual cash flow $323,960 Part 2 Payback Period years 4.85 Part 3 Accounting Rate of Return Accounting income as result of decreased costs $244,000 Annual cash savings $337,800 Less depreciation $125,000 Before tax income 212,800 Tax at Current Rate 63,840 After tax income $148,960 Accounting Rate of Return 9.49%61 62 Part 4 Net Present Value 63 Before Tax After Tax PV Present 64 Item Year Amount Tax % Amount Factor Value 65 Cost of machine 0 66 Annual cash savings 1-10 67 Tax savings due to depreciation 1-10 68 Disposal value 10 69 70 Net Present Value 71 72 Part 5 Internal Rate of Return and Modified Internal Rate of Return 73 74 After Tax 75 Item Year Amount 76 Cost of machine 77 Year 1 inflow 78 Year 2 inflow 79 Year 3 inflow 80 Year 4 inflow 81 Year 5 inflow 82 Year 6 7nflow 83 Year 7 inflow 84 Year 8 inflow 85 Year 9 inflow 86 Year 10 inflow 87 BB 89 90 Internal Rate of Return 91 Modified Internal Rate of Return 92 Net Present Value 93 94