Question

Community Challenges, a nonprofit organization for physically and mentally challenged people, manufactures a variety of products in four plants located in California. The company is currently purchasing an electronic igniter from an outside supplier for $62 per unit. Because of supplier reliability problems, the company is considering producing the igniters internally in a currently idle manufacturing plant. Annual volume over the next five years is expected to total 400,000 units at variable manufacturing costs of $60 per unit. Management must hire a factory supervisor and assistant for a total annual salary and fringe benefit package of $95,000.
In addition, the company must acquire $60,000 of new equipment. The equipment has a five-year service life and a $12,000 salvage value and will be depreciated by the straight-line method. Repairs and maintenance are expected to average $4,500 per year in years 3–5, and the equipment will be sold at the end of its life.

Required:
1. Should discounted cash flows be used in this outsourcing decision? Why?
2. Ignoring your answer to requirement (1), use the net-present-value method (total-cost approach) and a 14 percent hurdle rate to determine whether management should manufacture or outsource the igniters.
3. Suppose management is able to negotiate a lower purchase price from its supplier. At what purchase price would management be financially indifferent between manufacturing and outsourcing the igniters?



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  • CreatedApril 22, 2014
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