1) Using expected value, is it economically better to make or buy the component?
In this particular case study, we can look at two different scenarios - (a) the cost of manufacturing the components and (b) the cost of purchasing the components. Please refer to the following table to calculate the manufacturing costs for the components: 10,000
10,000
10,000
10,000
10,000
40
40
40
40
40
Defective unit replacement
120
120
120
120
120
Defect %
0%
10%
20%
30%
40%
10%
20%
30%
25%
15%
One time charge
$100,000
$100,000
$100,000
$100,000
$100,000
Total material cost
$400,000
$400,000
$400,000
$400,000
$400,000
No. of defective units
0
1,000
2,000
3,000
4,000
Cost of defective units
0
$120,000
$240,000
$360,000
$480,000
Replacement cost of units in addition to total cost of 10,000 units
$500,000
$620,000
$740,000
$860,000
$980,000
Cost Probability
$50,000
$124,000
$222,000
$215,000
$147,000
No. of units Material cost per unit
Probability of occurrence
Expected value to manufacture: $758,000
The cost for purchasing the components is guaranteed to be defect free and is fixed. The expected cost of purchasing 10,000 components is (= 10,000 x 72) = $720,000.00. Upon comparing the two calculations, it is clear that buying the components is cost effective and will result in savings of $38,000.00 ($758,000.00 ($758 ,000.00 - $720,000.00).
2) Strategically thinking, why might management opt for other than the most economical choice?
To determine any strategy, Teloxy must think about the short term and long term goals which are important to them for a successful and profitable business venture. For short term goals, the company might look at the economical choice. But if Teloxy wants to be a major player in the competitive market, they must focus on the long term goal of sustainability. If the demand for the product is expected to increase in the near future, Teloxy might consider manufacturing the component in-house. This decision would be made in part due to improved efficiency as they move forward on the learning curve, and reducing the number of defective components. This also helps Teloxy minimize their dependence on external resources and thereby avoid the risks associated with the unavailability of resources of higher purchase cost in the future.
