Question

1. Galt Motors currently produces 500,000 electric motors a year and expects output levels to remain steady in the future. It buys armatures from an outside supplier at a price of $2.50 each. The plant manager believes that it would be cheaper to make these armatures rather than buy them. Direct in-house production costs are estimated to be only $1.80 per armature. The necessary machinery would cost $700,000 and would be obsolete in 10 years. This investment would be depreciated to zero for tax purposes using a 10-year straight line depreciation. The plant manager estimates that the operation would require additional working capital of $40,000 but argues that this sum can be ignored since it is recoverable at the end of the ten years. The expected proceeds from scrapping the machinery after 10 years are estimated to be $10,000. Galt Motors pays tax at a rate of 35% and has an opportunity cost of capital of 14%. The incremental free cash flow that Galt Motors will incur in year 10 if they elect to manufacture armatures in house is closest to:

Answer is 298,500 but I can't figure out how. Any help is appreciated!

Answer 1

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