A U.S. company is currently producing a product in house with a yearly fixed cos

Question

A U.S. company is currently producing a product in house with a yearly fixed cost of $5 million and a variable cost of $3 per unit. A Chinese subcontractor can produce the product with equal quality for a yearly fixed cost of $3 million and a variable cost of $6 per unit.

a) What is the break-even quantity in this make-or-buy decision? Please include the formula, at least one step of calculation, and the correct answer for full credit. (5 points)

b) If the expected production quantity is 1 million units, should the company make or buy? Why? (3 points)

c) Suppose the Chinese subcontractor is willing to share the economies-of-scale benefits it might achieve in production and offers an incremental quantity discount on the variable cost. The subcontractor now charges $6 per unit for the first 0.5 million units in an order and $4 per unit for any additional units in the order. What is the break-even quantity in this case?

Explanation / Answer

a) 5000000+3Q = 3000000+6Q Therefore Q = 666667 units. b) 5M + 3*1M and 3M + 6*M 8M < 9M The company should make the product as variable cost is high for 1 million units. c) 5000000+3Q = 3000000+ 500000*6 + (Q-500000)*4 Q = 1 million

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