Question

X Company currently buys 7,500 units of a part each year from a supplier for $7.80 per part, but it is considering making the part instead. In order to make the part, X Company will have to buy equipment that will cost $150,000. The equipment will last for 6 years, at which time it will have zero disposal value. X Company estimates that it will cost $28,950 a year to make all 7,500 units.

What is the approximate rate of return if X Company makes the part instead of buying it from the supplier? [Note: 0.03 means 3%, etc.]

Answer 1

The approximate rate of return if X Company makes the part instead of buying it from the supplier is calculated below:

A)Total making cost = Total cost + Depreciation

Depreciation p.a. = (Cost - Salvage)/ Useful Life

=($150,000 - $0)/ 6 Years

= $150,000/ 6 years

=$25,000

Total making cost = $28,950 + $25,000

Total making cost = $53,950

B) Purchasing Cost = Puchasing in Units* Price Per Unit

= 7,500 Units*$7.80

= $58,500

  Purchasing Cost = $58,500

So Income(Saving )by making parts = Purchasing Cost - Total making cost

= $58,500 - $53,950

= $4,550

Rate of Return by making parts = $4,550/$53,950*100

=8.43%

The approximate rate of return if X Company makes the part instead of buying it from the supplier is 8.43%