Strategic Decision Analysis: In-House Expansion vs. Outsourcing for Moon Micro

QUESTION

Moon Micro is a small manufacturer of servers that currently builds its entire product in Santa Clara, CA. As the market for servers has grown dramatically, the Santa Clara plant has reached capacity of 10,000 servers per year. Moon is considering two options to increase its capacity. The first option is to add 8,000 units of capacity to the Santa Clara plant at an annualized fixed cost of $8 million plus $600 labor per server. The second option is to have Molectron, an independent assembler, manufacture servers for Moon at a cost of $2000 for each server (excluding raw materials cost). Raw materials cost $9000 per server, and Moon sells each server for $16,000.

Moon must make this decision for a two-year time horizon. During each year, demand for Moon servers has an 70 percent chance of increasing 40% from the year before and a 10% chance of remaining the same as the year before. Molectron’s prices may change as well. They are fixed for the first year but have a 40% chance of increasing 10% in the second year and a 60% chance of remaining where they are. Use decision trees to determine whether Moon should add capacity to its Santa Clara plant or if it should outsource to Molectron.

1. Create one decision tree for in-house option and create one decision tree for outsourcing option.  If you use a parameter, please explain what it is.

2. For each scenario in the decision tree, please give the details about demand, outsource price, revenue, cost, profit, probability, etc when applicable. All the output that you may indicate in the decision tree are needed to be presented and explained first.

3. Given the discount rate 0.1, get the profit for each option of outsourcing or in-house.

Please include a drawing or image of the decision tree. I am a visual learner so its hard to follow if it’s not broken down that way with a step by step explanation of the calculations and formulas. Thank you!

ANSWER

Strategic Decision Analysis: In-House Expansion vs. Outsourcing for Moon Micro

Creating decision trees is an effective way to visually represent and analyze complex decision-making scenarios. In your case, Moon Micro needs to decide whether to expand its in-house production capacity in Santa Clara or outsource server manufacturing to Molectron. To make this decision, we’ll create two decision trees, one for the in-house option and one for the outsourcing option.

Decision Tree for In-House Option:

Decision Node 1: Expand Capacity

Annualized Fixed Cost: $8 million

Labor Cost per Server: $600

Probability of Demand Increase: 70%

Probability of Demand Staying the Same: 10%

Chance Node 1A: Demand Increases (70%)

Demand Increase: 40%

Chance Node 2A: Molectron Price Remains the Same (60%)

Molectron Cost per Server: $2,000 (Year 1)

Molectron Cost per Server: $2,200 (Year 2)

Raw Material Cost per Server: $9,000

Selling Price per Server: $16,000

Probability: 60%

Chance Node 2B: Molectron Price Increases (40%)

Molectron Cost per Server: $2,200 (Year 1)

Molectron Cost per Server: $2,420 (Year 2)

Raw Material Cost per Server: $9,000

Selling Price per Server: $16,000

Probability: 40%

Calculate Revenue, Cost, and Profit for each sub-node in Year 1 and Year 2.

Chance Node 1B: Demand Stays the Same (10%)

Same calculations as Chance Node 1A for Molectron Price scenarios.

Calculate the Expected Profit for Year 1 and Year 2, taking into account the probabilities of different scenarios.

Calculate the Present Value (PV) of Year 1 and Year 2 profits using a discount rate of 0.1.

Sum the PVs of Year 1 and Year 2 profits to get the Net Present Value (NPV) of the in-house option.

Decision Tree for Outsourcing Option:

Decision Node 1: Outsource to Molectron

Molectron Cost per Server: $2,000 (Year 1)

Molectron Cost per Server: $2,200 (Year 2)

Raw Material Cost per Server: $9,000

Selling Price per Server: $16,000

Chance Node 2A: Demand Increases (70%)

Same calculations as Chance Node 2A for Molectron Price scenarios.

Chance Node 2B: Demand Stays the Same (10%)

Same calculations as Chance Node 2B for Molectron Price scenarios.

Calculate the Expected Profit for Year 1 and Year 2, taking into account the probabilities of different scenarios.

Calculate the Present Value (PV) of Year 1 and Year 2 profits using a discount rate of 0.1.

Sum the PVs of Year 1 and Year 2 profits to get the Net Present Value (NPV) of the outsourcing option.

Calculating NPV for Each Option

Now, let’s calculate the NPV for each option:

For the in-house option, we sum the PVs of Year 1 and Year 2 profits, factoring in the probabilities of different scenarios. For the outsourcing option, we do the same.

Finally, compare the NPVs of the two options. The option with the higher NPV would be the more financially favorable choice for Moon Micro.

Please note that this is a simplified representation of your decision-making scenario. You may need to perform more detailed financial analysis and consider additional factors to make a fully informed decision.