Question

Vintel Corporation has received a one-time contract to design and build 5,000 units of a new product. During the proposal process, management felt that the new product could the designed and manufactured at a low cost. One of the ingredients necessary to build the product was a small component that could be purchased for $30 in the market, including quantity discounts. Accordingly, management budgeted $350,000 for the purchasing and handling of 5,000 components plus scrap. During the design stage, the design team informs you that the final design will require a somewhat higher-grade component that sells for $36 with quantity discounts. The new price is substantially higher than what had been budgeted for. This will create a cost over-run. Project manager meet his manufacturing team to see if they can manufacture the component at a cheaper price than buying it from the outside. The manufacturing team informs that they can produce a maximum of 5, 000 units, just enough to fulfil the contract. The setup cost will be $50,000 and the raw material cost is $20 per component. Since Vintel Corporation has never manufactured this product before, manufacturing team expects the following defects:

Percent defective 0 10 20 30 40

Probability of occurrence 10 20 30 25 15

All defective parts must be removed and repaired at a cost of $60 per part.

Question: Is it economically better for Vintel Corporation to make or buy the component for the project? Use expected value criteria as a supporting analysis technique and show any relevant calculations.

Answer 1

To determine whether it is economically better for Vintel Corporation to make or buy the component for the project, we can use the expected value criteria. The expected cost of making the component can be calculated by considering the probability of defects and associated costs. This can then be compared to the market price to make a decision.

Step-by-step explanation:

To determine whether it is economically better for Vintel Corporation to make or buy the component for the project, we can use the expected value criteria. The expected value is calculated by multiplying the probability of occurrence by the cost associated with each defect. We can then compare the expected cost of making the component with the cost of buying it from the market.

First, let's calculate the expected cost of making the component:

Expected cost = (Probability of defect x Cost of repair) + (Probability of no defect x Setup cost + (Quantity x Raw material cost))

Using the given defect probabilities and costs, we can calculate the expected cost of making the component. After comparing the expected cost of making with the market price, we can determine if it is economically better to make or buy the component.