Calculate the incremental cash flows associated

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Problem: A bicycle manufacturer currently produces 500,000 units a year and expects output levels to remain steady in the future. It buys chains from an outside supplier at a price of $5 a chain. The plant manager believes that it would be cheaper to make these chains rather than buy them. Direct in-house production costs are estimated to be only $3 per chain.

The necessary machinery would cost $300,000 and would be obsolete after 10 years. This investment could be depreciated to zero for tax purposes using a 10-year straight-line depreciation schedule.

The plant manager estimates that the operation would require $75,000 of inventory and other working capital upfront (year 0), but argues that this sum can be ignored since it is recoverable at the end of the 10 years.

Expected proceeds from scrapping the machinery after 10 years are $25,000.

  • Calculate the incremental cash flows associated with producing the chains in-house for years 0-10.
  • What is the payback period of producing the chains in-house?

Reference no: EM132420624

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