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Anonymous
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1. Using expected rule, is it economically better to make or buy the component?

In the case study of Teloxy Engineering, initially, it has been decided that ten thousand pieces of components at $60 each should be bought. So, the total amount allocated for the procurement was $650,000 including $50,000 for scrap. Later it has been found that higher-quality component costing $72 each should be used for each product. But, it should numerically cost $720,000, excluding the scrap, if they are to proceed with the idea of procuring the higher quality material. Now, with the idea of the manufacturing team that they can produce equal quality material at $40 per piece but with $100,000 setup costs meant that the total cost of components now will stand at $(40X10,000 + 100,000) = $500,000. But, this amount is required without taking into consideration the probability of occurrence of defective pieces. According to what the manufacturing team has provided the probability of such occurrence should be either (10/100)X0= 0 or (20/100)X(10/100) = .02 or (20/100)X(30/100)=.06 or(30/100)X(25/100)=.075 or (40/100)X(15/100) =.06.In total, the probability is 0+.02+.06+.075+.06 or .215 or 21.5% of the 10,000 units produced or 2150 pieces. Now, the cost of repair of the defective products is $120 per defective piece or 2150X$120=$258,000. So, we have to consider and add this cost to the figure of $500,000. So, total cost of production stands at $(500,000+258,000) =$758,000.

Economically, it is marginally viable that they go for procurement than to go for manufacturing the parts for themselves.

2. Strategically thinking, why might management opt for other than the most economical choice?

Management might still consider the latter option if they foresee that they might require the same pieces for some other projects or as a continuation of the production of the same product in the future. In that case, since the setup cost has already been expended, they will only require the material cost to produce such components should the production continues. Otherwise, if it was a fixed quantity requirement, the former option of procurement should be considered as they still might be saving a bit of money. So, it should be well thought out by the management before taking such a decision.

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FPiper
School: University of Virginia

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Anonymous
Good stuff. Would use again.

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