Fresh Flour makes baking flour and sells its flour in 4 pound sacks or bags. The managers of Fresh Flour are considering whether the firm should make or buy the flour sacks. To make the sacks, Fresh Flour needs a $500,000 piece of equipment. Using this equipment, Fresh Flour can make a flour sack for $0.01 and, for simplicity, ignore taxes and assume that the $0.01 cost includes depreciation and

Question

all other costs. Fresh Flour would finance the $500,000 investment using its own funds and, if it purchased the flour sacks from another firm, it would pay $0.19 a flour sack. The life span of the equipment is 10 years and it has no salvage value at the end of the ten years. If the discount rate is 6 percent and the firm needs 400,000 flour sacks a year. Which of the following statements is true?

A) Fresh Flour should not invest in the equipment because the net present value is negative.
B) Fresh Flour should invest in the equipment because the net present value is negative.
C) Fresh Flour should not invest in the equipment because the net present value is positive.
D) Fresh Flour should invest in the equipment because the net present value is positive.

Answer 1

D) Fresh Flour should invest in the equipment because the net present value is positive.