QWA Electronics is considering between two alternatives for their electronic com
ID: 1217702 • Letter: Q
Question
QWA Electronics is considering between two alternatives for their electronic components' needs. A high-use component(expected usage or capacity is 5,000 units per year) can be purchased(bought) for variable cost of $25 per unit with quick delivery. Alternatively, QWA can make the components in-house and have it already available at a variable cost of $5 per unit. To do that, QWA needs to purchase equipment today at $150, 000. Labor and other operating costs are estimated to be $35,000 per year over the study period of 5 years. Salvage value is estimated at 10% of first cost and interest rate is 12% per year. Determine the breakeven quantity. Indicate whether to buy or make the components at five expected usage level of 5,000 units per year. Explain your answer.Explanation / Answer
Present cost of equipment = $150000
Annual labor and operating cost = $35000
Salvage value = 10% of initial machine cost = $15000
n = 5 years
R = 12%
Here, we have to calculate equivalent annual cost. First, we will calculate the present value of all costs.
Present value of investment = 150000 + 35000*(1-1/(1+12%)^5)/12% - 15000/(1+12%)^5
Present value of investment = $267655.76
Let, equivalent annual cost = EAC
267655.76 = EAC*(1-1/1.12^5)/.12 = EAC*3.60
EAC = 267655.76/3.6
EAC = $74348.82
a.
Break even quantity = EAC /(Purchase price – Make variable cost)
Break even quantity = 74348.82/(25-5) = 3717.41 or 3718 units approx.
b.
At expected usage level of 5000 units
Cost paid in purchase decision = 5000*25 = $125000
Cost paid in make decision = EAC +$5*5000 = $74348.82 +$25000 = $99348.82
Net savings when company go for make decision = 125000 - 99348.82 = $25651.18
Company should go for make or in-house manufacturing decision at annual usages of 5000 units because it gives the net savings of $25651.18.