Johnson Products now buys a certain part for its chain saws. The managers are considering the production of the part in-house. They can install a production system that would have a life of five years with no salvage value. They believe that over the next five years the real price of purchased parts will remain fixed.
They expect the real price of labour and other inputs to production to rise over the next five years. Further information about the situation is in the table below.
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Annual cost of purchase ($/year)
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750000
|
|
Expected real change in cost of purchase
|
0%
|
|
Expected real change in labour cost
|
4%
|
|
Expected real change in other operating costs
|
2%
|
|
Labour cost/unit (first year of operation) ($)
|
10.5
|
|
Other operating cost/unit (first year of operation) ($)
|
9
|
|
In-house first cost($)
|
200000
|
|
Use rate (units/year)
|
25000
|
|
Current dollar MARR
|
20%
|
|
Study period (years)
|
5
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1. Assume inflation is 2 percent per year in the first year of operation. What will be the current dollar cost of labour for in-house production in the second year?
2. Assume inflation is 2 percent per year in the first two years of operation. What will be the current dollar cost of other operating inputs for in-house production third year?
3. Assume that inflation averages 2 percent per year over the five-year life of the project. What is the present worth of costs for purchase and for in-house production?