4) An industrial firm can manufactures several lines of pressure washers. The de
ID: 2652402 • Letter: 4
Question
4) An industrial firm can manufactures several lines of pressure washers. The demand for a particular component required for a pressure washer is 120,000 per year. The firm has the following two options: Buy option: A supplier is willing to provide this component at a unit sales price of $ 35.00, if at least 100,000 units are ordered annually. Make option: The machine that can be used to manufacture this component costs $ 2, 200,000 now and will have a salvage value of $ 120,000 after the economic life of five years. The manufacturing cost per unit including the direct material and labor and the variable and fixed factory overhead only is $ 30.00. In addition, the annual maintenance cost of the machine is $ 100,000. Calculate the unit cost under each of the above two options and choose the best option. Assume that the firm?s interest rate is 12 %, compounded annually.Explanation / Answer
Option (1) Buy Option
Unit sales price = 35$ , particular component required = 1,20,000 per year
Five Years component required cost for pressure washer = 35$ * 1,20,000 * 5 = 21 million $
Unit cost = 21000000/(1,20,000*5) = 35 $ per unit
Option (2) Make Option
Machine cost (including interest cost @12% compounded annually) = 2,200,000 *(1+ .12)^5 =3,876,400$
(a) Effective Machine cost (deducting salvage value = 3,876,400 - 120,000 = 3.756400 million $
(b) Manufacturing cost for five years (including direct material, labor, factry overhead) = 1,20,000 *5 * $30 = 18 million $
(c) Maintenance cost of the machine for five years = $100,000 * 5 = .5 million $
Total cost (a)+(b)+(c) = 3.75 +18 +.5 = 22.25 million $
Unit cost = 22,250,000 /(1,20,000*5) = 37.08 $ per unit
Unit cost for make option is greater than buy option. Hence, the best option is to Option (1) Buy Option
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