Control of quality and on-time delivery

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Reference no: EM133017208

Question: The estimated purchase price for the equipment required to move the operation in-house would be $900,000. Additional net working capital to support production (in the form of cash used in Inventory, AR net of AP) would be needed in the amount of $40,000 per year starting in year 0 and through all years of the project to support production as raw materials will be required in year o and all years to run the new equipment and produce components to replace those purchased from the vendor..

• The current spending on this component (i.e. annual spend pool) is $1,500,000. The estimated cash flow savings of bringing the process in-house is 20% or annual savings of $300,000. This includes the additional labor and overhead costs required.

• Finally, the equipment required is anticipated to have a somewhat short useful life, as a new wave of technology is on the horizon. Therefore, it is anticipated that the equipment will be sold after the end of the project (the last year of generated cash flow) for $50,000. (i.e. the terminal value).

David, the Product Manager, is convinced the new capability will allow better control of quality and on-time delivery, and that it will last longer than 5 years. He recommends using a 7 Year Equipment Life (which means a 7-year project and that savings will continue for 7 years), flat annual savings, and 12% discount rate. In other words, assume that the machine will last 2 more years and deliver 2 more years of savings. David also feels the equipment will have an estimated terminal value of $25,000 at the end of its 7- year useful life as it will be utilized longer thus having less value at the end of the project and savings.

Reference no: EM133017208

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