United Metal

1.

United Metal: Current Situation

Manufacturing components

• 100,000 units/year • £40,000 / year • £50,000 / year Raw Materials

Other Direct Costs

• Product Life is 8 years • Machine Cost £45,000 over a year ago.

The Offer: • Buy in at 83 pence per unit • Renewable one-year contract

2. United Metal: The Arguments

Production Manager: • £35,500 loss on machine Extra Inventory: • 15,000 vs. two weeks • Extra 10% of warehouse Chief Operator: • Moves to £7,000 job • Paid £8,000 Purchasing Manager: • Extra inventory is not relevant • Warehouse: only 60% is utilized, no extension for 4 years, hence space is free. • Chief Operator move: trivial.

3. Chief Operator

Cost Item Raw Materials Manufacturing (incl. Operator) Operator (Other Dept.) Purchase of Components Total

The Without Case Make -40,000 -50,000 -7,000 0 -97,000

The With Case Buy 0 0 -8,000 -83,000 -91,000

With minus Without Savings 40,000 50,000 -1,000 -83,000 6,000

4. Machine sale in case of Buy option Cash Flow = 5,000 + 12.425 • Proceeds from sale: 5,000 • Tax effect o Book value of machine =45,000-4,500=44,500. o Book gain(loss if negative)= 5,000-44,500=-35,500 o Cash flow =35%×35,500=12,425 because it is a book loss so we get a tax credit

5. Inventory (WC) Type Raw Materials Finished Components Total

Make

2 weeks supply = £40,000 x 2 52

2 52

Buy Zero 15,000 Items = £15,000 x 0.83 £12,450

2 weeks supply = £90,000 x

£130,000 x

2 = £5,000 52

Hence an Incremental Cost of £7,450

Cash Flows (thousands) Make Stock NWC, pro-forma balance sheet Increase (Decrease) NWC Cash Flow = −Increase NWC Buy Stock NWC Increase(Decrease) in NWC Cash Flow Difference (Buy – Make) Yr -1 5.0 Yr 0 5.0 0 0 12.45 7.45 (7.45) (7.45) Yr 1 5.0 0 0 12.45 0 0 0 Yr 2 5.0 0 12.45 0 0 0 ... ... ... ... Yr 7 5.0 0 12.45 0 0 0 Yr 8 0 (5) 5 0 (12.45) 12.45 7.45

5.0

6. Warehouse Extension

Decision Buy Make Capex Dep. Tax Shield Capex Dep. Tax Shield Yr 3 -50 Yr 4 0 .7...