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Number of defective units: (0.2*1000) +(0.3*2000) +(0.25*3000) + (0.15*4000)
= 2150.
Repair cost: 2150*120 = 258,000.
Therefore, to manufacture part cost is estimated to be: (258,000 + 400,000 + 100,000)
=758,000
Part can be bought from market at $72 per unit: 10,000 * 72 = 720,000
So, by buying that part we can save 758,000 – 720,000 = 38,000.
Based on the above calculations as well as economically considering it would seem prudent to buy the part rather than manufacture it.
2) Strategically thinking, why might management opt for other than the most economical choice?
Although it would be better for the company to buy the product, the management would opt for producing it in house. There are certain benefits of doing so:
One of the biggest advantages for the company to manufacture the product in-house it allows the manufacturers flexibility in working around the requirements of the product. During the process of building the new product in case any change in required.
Make changes as per market requirement: Flexibility can allow management to move around with designs, engineering, product development and product phases in easier manner. On the other hand if the product was outsourced, there could be certain issues that could come to the front. If market requirements change and the company cannot work around those requirements it leaves the company waiting on the product in a lurch.
Teloxy Engineering never having manufactured the product before is hence bearing the high manufacturing cost and would have to consider the risk of defects and later their high repair costs.
They also would have the advantage of selling the products at lower cost when producing in lesser quantities.
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