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A pencil company currently produces 200,000 units a year. It buys pencil tops from an...

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Finance

  1. A pencil company currently produces 200,000 units a year. It buys pencil tops from an outside supplier at a price of $2 per top. The plant manager believes that it would be cheaper to make these tops rather than buy them. Direct production costs are estimated to be only $1.50 per top. The necessary machinery would cost $150,000. This investment could be written off for tax purposes using straight-line depreciation over 8 years with no salvage value. The plant manager estimates that the operation would require an additional working capital investment of $30,000 that is recoverable at the end of the 10 years. If the company pays tax at a rate of 35% and the cost of capital is 15%, would you support the plant managers proposal? Assume the machinery can last for at least 10 years and all operating cash flows occur at the end of the year.

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