1: What is the NPV of purchasing vs. assembling ? (provide details of the calculation).
|Annual cash out flows of Purchasing (Year 1 to Year 5)||= $100,000 *8.3* (1 – 35%) =||539500|
|Additional cost of manager salary= 10000 per year|
|total Annual cost of Purchasing||549500|
|Disposal value subtracted from the 1st year’s cost of purchasing||50000|
|Variable Dimension Sensor Price to be added to 1st year’s cost||80000|
|Year||Cost||NPV at 20%|
|Total Cost of Purchasing||2560223|
|Total Annual cost of Assembling|
|Raw Material Costs||400000||400000||400000||400000||400000||400000||400000||400000|
|Cost of manager||80000||80000||80000||80000||80000||80000||80000||80000|
|Total Costs before dep.||980000||980000||980000||980000||980000||980000||980000||980000|
|total Costs after Dep.||1070000||1070000||1070000||1070000||1070000||980000||980000||980000|
|Corporation tax savings @ 35%||374500||374500||374500||374500||374500||343000||343000||343000|
|Total Costs After Tax||605500||605500||605500||605500||605500||637000||637000||637000|
|NPV at 20%||605500||504583||420486||350405||292004||255996||213330||177775|
|It is assumed that all costs incurred at the beginning of the year|
2: What are other issues you should take into account when making the decision?
There are other important issues to be considered before making the decision to shutting down the assembling department. The company should consider the quality of the component buying vs. making it in house. Making a component in house may give customer more satisfaction than they get when they know company used other’s components in their products as well. The company should also know the cost of shortage if the current supplier fails to deliver component on time. The company should also consider whether there is some competitive advantage of using an own produced component and whether they can offer one in the market with increased production and thus bringing a more revenue stream to the company’s product portfolio.
The company should also have contigent plans in place in case the vendor failes to provide component in the required period for some reason and should always have one supplier in the pipeline to be contacted for the component if current supplier refuse to do so. This is because if there is no alternative arrangement, Frontech corporation’s refusal to provide the component or in case of shortage due to any other reason, the primary product would suffer drastically. The company should take all these things in mind before continuing with the project.