Question

Archimodo Inc. currently produces 500,000 electric scooters a year and expects output levels to remain steady in the future. It buys subassemblies from an outside supplier at a price of $3.50 each. The plant manager believes that it would be cheaper to make these subassemblies rather than buy them. Direct in-house production costs are estimated to be only $1.80 per subassembly. 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 after tax proceeds from scrapping the machinery after 10 years are estimated to be $10,000. Archimoto pays tax at a rate of 20% and has an opportunity cost of capital of 14%. The incremental cash flow that Archimodo will incur in year 10 if they elect to manufacture subassemblies in house is closest to:

Select one:

a. $750,000

b. $600,000

c. $700,000

d. $650,000

e. $800,000

Answer 1

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