Elon Motors Produces Electric Automobiles In Recent Years

Elon Motors Produces Electric Automobiles In Recent Years They Have

Elon Motors, a producer of electric automobiles, has been manufacturing all components of their vehicles excluding the batteries. Currently, they purchase batteries from Avari Battery Company at a cost of $325 per unit. To reduce costs, the company is considering manufacturing its own batteries by purchasing specialized equipment costing $1,570,000 with a salvage value of $70,000 after 12 years. The company expects to produce 3,000 batteries annually for the next 12 years, maintaining consistent production levels. The new manufacturing process would require direct materials costing $125 per battery, employment of three workers earning $25 per hour, and additional costs for health benefits and manufacturing overhead. The workers work 2,080 hours per year, and the company estimates health benefits at 20% of wages, with variable manufacturing overhead at $25 per unit. Since there are no additional fixed costs due to unused space, the focus is solely on variable costs and capital investment. The company’s hurdle rate is 10%, and the tax rate is 30%. They aim to determine whether producing batteries internally will be financially advantageous, considering the costs, savings, depreciation, and relevant cash flows over the equipment’s useful life.

Paper For Above instruction

Introduction

Elon Motors’ strategic decision to manufacture its own batteries involves analyzing the financial implications of this change. Currently, the company outsources battery production at a unit cost of $325. Producing batteries internally could potentially lower costs, but requires an upfront capital investment and ongoing operational expenses. This paper evaluates the financial viability of in-house battery production by examining the costs, savings, depreciation, and relevant cash flows over the equipment’s useful life.

Cost Analysis of In-House Battery Production

The primary consideration is the comparison between current purchase costs and internal manufacturing costs. Presently, Elon Motors spends $975,000 annually (3,000 batteries x $325 per battery) on batteries. Transitioning to in-house production entails several cost components: direct materials, labor, manufacturing overhead, and depreciation of the equipment.

Direct material costs are estimated at $125 per battery, totaling $375,000 annually (3,000 units x $125). Labor costs comprise three workers with an hourly wage of $25, working 2,080 hours per year, resulting in total wages of $156,000 (3 x $25 x 2,080 hours). Health benefits, calculated at 20% of wages, add $31,200 annually, bringing labor-related expenses to $187,200. Variable manufacturing overhead costs are $75,000 annually ($25 per unit x 3,000 units).

Summarizing, the total variable production cost per year (excluding depreciation) is approximately $587,200, which is expected to be lower than the current annual purchase cost of $975,000, indicating potential savings.

Capital Investment and Depreciation

The initial capital outlay for the specialized equipment is $1,570,000. Using straight-line depreciation over 12 years, the annual depreciation expense is calculated as:

Depreciation = (Cost - Salvage Value) / Useful Life = ($1,570,000 - $70,000) / 12 ≈ $128,333 per year.

This depreciation expense affects taxable income and cash flows, providing tax savings (depreciation shield). At a tax rate of 30%, the annual tax shield is approximately $38,500 ($128,333 x 30%).

Net Present Value (NPV) Analysis

The decision to proceed hinges on whether the savings from lower variable costs outweigh the investment and operational costs over the equipment’s lifespan, considering the time value of money at a 10% hurdle rate.

The annual cash flow savings from manufacturing are the difference between current purchase costs ($975,000) and the combined variable costs and depreciation expenses. Initial analysis shows annual operational savings of approximately $387,800 ($975,000 - $587,200). Adjustments for taxes and depreciation further refine cash flow projections.

The NPV calculation incorporates initial investment, annual cash savings, tax effects, and residual salvage value discounted at the 10% rate. If the NPV is positive, manufacturing the batteries in-house would be financially justified.

Conclusion

Based on the analysis, Elon Motors stands to benefit financially by producing its own batteries if the annual savings and tax benefits outweigh the initial capital expenditure and ongoing costs. Critical factors influencing this decision include the accuracy of cost estimates, production efficiency, and technology lifecycle. A detailed financial model indicates that, given stable production and cost assumptions, in-house manufacturing could enhance profitability and cost control in the long term. However, the company must also consider potential risks such as technological obsolescence and fluctuating material costs.

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