Question

JDI, Inc. is trying to decide whether to make or buy a part (#J-45FPT). Purchasing the part would cost $1.30 each. If they design and produce it themselves, it will result in a per unit cost of $0.82. However, the design investment would be $40,000. Further, they realize that for this type of part, there is a 25% chance that the part will need to be redesigned at an additional cost of $50,000. Regardless of whether they make or buy the part, JDI will need 80,000 of these parts. Using decision trees analysis and EMV, what should JDI do? Show the decision tree.

Answer 1

After analyzing the decision using a decision tree and calculating the Expected Monetary Value (EMV), JDI, Inc. should buy the part as it has a lower total cost ($104,000) compared to the EMV of making the part ($118,100).

Step-by-step explanation:

JDI, Inc. is considering whether to make or buy a part (#J-45FPT). To analyze the decision, we must consider the costs associated with both options and apply a decision tree analysis using Expected Monetary Value (EMV).

Decision Tree Analysis

Calculate the total cost of buying the part: 80,000 parts × $1.30 each = $104,000.

Calculate the total cost of making the part without redesign:

Initial design investment = $40,000.

Production cost = 80,000 parts × $0.82 each = $65,600.

Total cost without redesign = $40,000 + $65,600 = $105,600.

Calculate the cost of making the part with redesign:

Redesign cost = $50,000 (additional).

Total cost with redesign = $105,600 (from step 2) + $50,000 = $155,600.

Calculate the EMV for making the part (including the probability of redesign):

EMV without redesign (75% chance) = 0.75 × $105,600 = $79,200.

EMV with redesign (25% chance) = 0.25 × $155,600 = $38,900.

Total EMV for making = $79,200 + $38,900 = $118,100.

Comparing the total cost of buying ($104,000) with the EMV of making the part ($118,100), JDI should choose to buy the part, as this option is less expensive.