Question

You are the owner of a successful fanny-pack company. your fanny-packs are selling

well. So well that you are considering adding a premium fanny-pack to your line-up of goods. Your

marketing department estimates that you will be able to sell $5 million worth of the premium fanny-

packs annually. Unfortunately, the team informs you that the premium product will not attract new

fanny-pack customers. Rather, the sales of premium packs will cannibalize your existing sales in a 1-to-1

ratio. For every premium fanny-pack you sell for $50, you sell one fewer regular fanny-pack (which

retails for $20). Luckily, both styles of fanny-pack use the same raw materials in the same quantities, so

the costs of goods sold will remain unchanged, and your inventory requirements will be unaffected. You

plan on selling fanny-packs indefinitely, but don't expect sales to increases year-over-year. Your firm's

effective tax rate is 30%, and your cost of capital is 8.5%

(a) The premium nature of these fanny-packs derives from the intricate sewing techniques which

must be used. The only machines capable of such delicate work are produced only in Italy, and

cost an astounding $20 million. If purchased today, the machine will be working by tomorrow.

Moreover, these machines, while beautiful, are notoriously expensive to maintain. If you buy the

machine, you can expect your annual maintenance costs to increase by $250 thousand. Should

you buy the machine?

(b) Alternatively, you learn that a large purse manufacturer has a machine capable of sewing the

premium fanny-packs, and that manufacturer is willing to construct them for you. The purse

company offers the following deal: You supply them with the necessary inventory of raw goods,

and you pay them $30 for each premium fanny-pack made. The pure manufacturer is responsible

for all maintenance costs associated with their machines. Furthermore, the purse company is

willing to let you pay the $30 three months after the date of the sale. Should you take the deal?

Answer 1

option a machine should be purchased because cost of machine is $250 thousand which is less than $20 million which is paid to italy for production of premium fanny packs. so machine should be baught.

option b we have to pay $30 for each premium fanny packs so total cost is $ 30*10000= $300000 because we can sell premium funny packs for worth $5million and selling price is $ 50 for each so number of units is $5 million / $50= 10000

if we have to decide whether machine is bought or work to be done from outsiders so i suggest machine should be bought because of low cost.