Question -

Sure Fire Company manufacture a variety of products in four plants located in Sydney. The company is currently purchasing an electronic igniter from an outsider supplier for $62 per unit. Because of a supplier reliability problems, the company is considering producing the igniter internally in a manufacturing plant that is currently unused. Annual volume over the next five years is expected to total 400 000 units at variable manufacturing costs of $60 per unit. Management must hire a factory supervisor and assistant for a total annual salary and fringe benefit package of $95 000. In addition, the company must acquire $60 000 of new equipment. The equipment has a five service life and a $12 000 salvage value, and will be depreciated by the straight-line method. Repairs and maintenance are expected to average $4 500 per year in years 3-5, and the equipment will be sold at the end of its life. (Ignore income taxes).

Required:

1. Should discounted cash flow be used in this outsourcing decision? Why?

2. Ignoring your answer to requirement 1, use the net present value method (total cost approach) and a 14 per cent hurdle rate to determine whether management should manufacture or outsourcing the igniters.

3. Suppose management is able to negotiate a lower purchase price from its supplier. At what purchase price would management be financially indifferent between manufacturing and outsourcing the igniters?