Reference no: EM133098763

Question - A bicycle manufacturer currently buys bicycle chains from an outside supplier at $2 a chain. It requires 300,000 bicycle chains a year. The plant manager believes that it would be cheaper to make these bicycle chains rather than buy them. Direct in-house production cost is estimated to be only $1.50 per chain. To produce the bicycle chains, it would cost $250,000 to purchase the necessary machine and $20,000 to deliver and install it today. The machine is expected to start producing the chains in the first year. The plant manager estimates that the in-house production would require an additional cost of $50,000 each year. The machine is expected to last for ten years, after which it is expected to be sold for $20,000.

60% of the fund for the project is financed through debt which has a cost of 6% per annum and shareholders require a return of 10% per annum.

a) Draw the timeline and set out the NET cash flow for each year.

b) Calculate the weighted average cost of capital (WACC) of this project.

c) Calculate the Net Present Value (NPV) of this project and explain if this project should be accepted according to the NPV rule.

d) If this project's weighted average cost of capital increases, how would this change affect the NPV of this project and the decision made using the NPV approach?