Question

X Company currently makes 7,500 units of a component part each year, but is considering buying it from a supplier for $8.00 each. The current annual cost of making the part is $64,700. The supplier wants X Company to sign a contract for the next six years. If X Company buys the part, it will be able to sell the equipment that it currently uses to make the part for $16,000, but the equipment will have no salvage value at the end of six years. Assuming a discount rate of 4%, what is the net present value of buying the part instead of making it?

Answer 1

Calculation of the net present value of buying the part instead of making it
Year	0	1	2	3	4	5	6	NPV
Sale of equipment	$16,000.00
Cost savings		$4,700.00	$4,700.00	$4,700.00	$4,700.00	$4,700.00	$4,700.00
Net Cash flows	$16,000.00	$4,700.00	$4,700.00	$4,700.00	$4,700.00	$4,700.00	$4,700.00
x Discount Factor @ 4%	1	0.961538	0.924556	0.888996	0.8548042	0.821927	0.790315
Present Values	$16,000.00	$4,519.23	$4,345.41	$4,178.28	$4,017.58	$3,863.06	$3,714.48	$40,638.04
The net present value of buying the part instead of making it =					$40,638.04
Working
Annual cost of making the part = $64700
Annual cost of buying the part = 7500 units * $8 = $60000
Annual cost savings = $64700 - $60000 = $4700