Potato Head Enterprises (PHE) currently purchases 50,000 units a year from its widget supplier for its manufacturing process. Each widget costs $8.50 from this supplier. PHE is considering whether to purchase a machine to produce the widgets internally. The machine would cost $250,000 today but would produce the widgets at a cost of $6.00 each. The machine would be depreciated over a useful life of 10 years, after which its salvage value would be $0. Operating the machine would also require PHE to tie up an additional $45,000 in net working capital today, which it would recover in year 10. PHEs corporate tax rate is 35 percent and its weighted average cost of capital is 15 percent. Assume a 10-year time frame for the analysis.

Calculate the incremental cash flows from making the parts in house compared to purchasing them from an outside supplier. Use the incremental IRR rule to decide whether PHE should make the parts in house. Make sure you explain how you have applied the incremental IRR rule.