Economic Feasibility Analysis: Make or Buy Decision for Teloxy Engineering (B)

QUESTION

Teloxy Engineering (B)
Your manufacturing team informs you that it has found a way to increase the size of the
manufacturing run from 10,000 to 18,000 units, in increments of 2,000 units. However, the setup
cost will be $150,000, and defects will cost the same $120 for removal and repair.
QUESTIONS
1. Calculate the economic feasibility of make or buy.
2. Should the probability of defects change if we produce 18,000 units as opposed to
10,000 units?
3. Would your answer to question 1 change if Teloxy management believes that
follow-on contracts will be forthcoming? What would happen if the probability of defects
changes to 15 percent, 25 percent, 40 percent, 15 percent, and 5 percent due to learning-
curve efficiencies?

ANSWER

Economic Feasibility Analysis: Make or Buy Decision for Teloxy Engineering (B)

Introduction

In this essay, we will analyze the economic feasibility of the make or buy decision for Teloxy Engineering (B). The scenario involves a manufacturing team that has discovered a way to increase the production run from 10,000 to 18,000 units, with incremental steps of 2,000 units. However, there are setup costs involved and potential defects that incur removal and repair expenses. We will address three key questions to evaluate the economic viability of this decision.

Economic Feasibility of Make or Buy Decision

To determine the economic feasibility, we need to compare the costs of producing the additional units in-house versus outsourcing the production. Let’s examine the costs associated with each option:

In-House Production

Setup Cost: The setup cost for increasing the manufacturing run is $150,000. This cost remains constant regardless of the number of units produced.
Defect Cost: Defects are estimated to cost $120 per unit for removal and repair.

Outsourcing Production

The outsourcing cost per unit would depend on the chosen supplier’s pricing structure. If the outsourcing cost per unit is lower than the sum of the setup cost and defect cost per unit, it may be economically favorable to outsource the production.

To calculate the economic feasibility, we compare the total cost of producing 18,000 units in-house (including setup and defect costs) with the cost of outsourcing the same quantity. If the in-house cost is lower, it would be economically feasible to produce the units internally. Conversely, if the outsourcing cost is lower, it would be more advantageous to buy the units from an external supplier.

Impact of Production Quantity on Defect Probability

Increasing the production quantity from 10,000 to 18,000 units might impact the probability of defects. However, the given information does not explicitly state any correlation between production quantity and defect probability. Therefore, we cannot assume a direct relationship between these variables.

The defect probability can be influenced by various factors such as production processes, quality control measures, and the expertise of the manufacturing team. Without additional information, it is difficult to determine whether producing 18,000 units instead of 10,000 units would affect the defect probability.

Consideration of Follow-on Contracts and Changing Defect Probabilities

If Teloxy management believes that follow-on contracts will be forthcoming, it can significantly impact the make or buy decision. Follow-on contracts would imply a steady demand for the product, making in-house production more favorable in terms of long-term cost efficiency, control, and potential revenue.

Moreover, if the probability of defects changes due to learning-curve efficiencies, it can influence the overall costs and feasibility. The learning curve suggests that as workers gain experience and familiarity with the production process, defect rates tend to decrease, leading to cost savings. If the defect probability decreases with experience, it could make in-house production more economically viable.

On the other hand, if the defect probability increases, it may raise the cost of in-house production and make outsourcing more attractive.

Conclusion

To assess the economic feasibility of the make or buy decision, we need to compare the costs of in-house production with the costs of outsourcing, considering the setup cost and defect expenses. Additionally, factors like the probability of defects and the anticipation of follow-on contracts must be taken into account.

It is crucial for Teloxy Engineering (B) to conduct a detailed cost analysis and consider the potential long-term benefits and risks associated with each option. By thoroughly evaluating these factors, Teloxy can make an informed decision that aligns with its financial objectives, production capabilities, and market demands.