Teloxy Engineering has received a one-time contract to design and build 10,000 units of a new product. During the proposal process, management felt that the new product could be designed and manufactured at a low cost. One of the ingredients necessary to build the product was a small components plus scrap. During the design stage, your engineering team informs you that the final design will require a somewhat higher-grade component that sells for $72 with quantity discounts. The new price is substantially higher than you had budgeted for. This will create a cost overrun. You meet with your manufacturing team to see if they can manufacture the component at a cheaper price than buying it from the outside. Your manufacturing team informs you that they can produce a maximum of 10,000 and the raw material cost is $40 per component. Since Teloxy has never manufactured this product before, manufacturing expects the following defects: All defective parts must be removed and repaired at a cost of $120 per part. Using expected value, is it economically better to make or buy the component? Strategically thinking, why might management opt for other than the most economical choice? your manufacturing team informs you that they have found a way to increase the size of the manufacturing run from 10,000 to 18,000 units in increments of 2000 units. However, the setup cost will be $150,000 rather than $100,000 for all production runs greater than 10,000 units and defects will cost the same $120 for removal and repair. Calculate the economic feasibility of make or buy. Should the probability of defects change if we produce 18,000 units as opposed to 10,000 units? Would your answer to question 1 change if Teloxy management believes that follow-on contracts will be forthcoming? What would happen if the probability of defects changes to 15 percent, 25 percent, and 5 percent due to learning-curve efficiencies?
Answer
1) cost of production = $(100000+40*10000)
cost/parts = total cost/10000 = $50
Now, considering defects parts cost
since each defective parts needs to be replaced with cost of
$120
so, total cost = 228000
adding this to cost of production, we get
Production cost/parts= 728000/10000= $72.8
Market value /parts = $72
Thus its economically better to buy the component
B)
1)economic feasibility depends upon the return on
investment(roi) which is given by
ROI = Present Value Of Benefits / Present Value Of Costs
if the roi is higher,more the process is economical feasible and
vice versa
i think in this case it is not economically feasible because the
value of cost is higher than the benefits range
2)yes the probability of defects will change as it depends upon
the number of products.so as it increases the probabilty
increases.
3)yes the economic feasibility could change ina positive way if
the contract goes bigger as their is more chance of getting higher
rate of return on each component.so it will change.
A 1) economically speaking it is better to make the component
because of the cost of component can be decided by the management
itself as they can use cheao material to maintain their budget.
2)strategically speaking management should go for this contract
and buy the component beacuse they are new to thi product and want
to make their mark in the industry so they cant take risk..so they
should keep risk management in their mind.
B1)economic feasibility depends upon the return on
investment(roi) which is given by
ROI = Present
Value Of Benefits / Present Value Of Costs
if the roi is
higher,more the process is economical feasible and vice
versa
i think in
this case it is not economically feasible because the value of cost
is higher than the benefits range
2)yes the probability of defects will change as it depends upon
the number of products.so as it increases the probabilty
increases.
3)yes the economic feasibility could change ina positive way if
the contract goes bigger as their is more chance of getting higher
rate of return on each component.so it will change.
A.
1) cost of production = $(100000+40*10000)
cost/parts = total cost/10000 = $50
Now, considering defects parts cost
since each defective parts needs to be replaced with cost of
$120
so, total cost = 228000
adding this to cost of production, we get
Production cost/parts= 728000/10000= $72.8
Market value /parts = $72
Thus its economically better to buy the component
