Modern Company manufactures wood desks. They have the opportunity to buy handles for the desks at $8 per unit. This purchase would affect costs as follows:

Make Buy

Unit selling price: $340 $340

Volume (monthly) 500 500

Unit variable cost $ 95 $ 88

Price to purchase $ 0 $ 8

Fixed costs $5,500 $4,700

Decide whether the part should be made or purchased.

A company is planning to buy a new machine at a cost of $200,000. The machine is expected to last for 10 years and have no salvage value at the end of its useful life. Straight-line depreciation will be used. The company expects to save 10,000 hours of direct labor each year because of the new machine, as well as $4,000 each year in other operating costs.

Managements best estimate is that on average the hourly rate for the labor saved will be $5.50. With the exception of the initial purchase, assume all cash flows take place at the end of the year, and a tax rate of 40%.

Required:

1. Calculate the payback period on the investment in new machinery.
2. Calculate the rate of return on the average investment.
3. Calculate the net present value of the investment and profitability index:

1. Ignoring income taxes, using a discount rate of 10%.
2. Including the effect of taxes, using a 10% discount rate.