Case Study 1
Teloxy Engineering has received a onetime 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 component that could be purchased for $60 in the marketplace, including quantity discounts. Accordingly, management budgeted $650,000 for the purchasing and handling of 10,000 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 units, just enough to fulfill your contract. The setup cost will be $100,000 and the raw material cost is $40 per component. Since Teloxy has never manufactured this product before, manufacturing expects the following defects:
|
% defective
|
0
|
10
|
20
|
30
|
40
|
|
probability of occurrence (%)
|
10
|
20
|
30
|
25
|
15
|
QUESTIONS
1. Using expected value, is it economically better to make or buy the component?
2. Strategically thinking, why might management opt for other than the most economical choice?