The Water Sports Company soon will be producing and marketing a new model line o

Question

The Water Sports Company soon will be producing and marketing a new model line of motor boats. The production manager, Michael Jensen, now is facing a make-or-buy decision regarding the outboard motor to be installed on each of these boats. Based on the total cost involved, should the motors be produced internally or purchased from a vendor? Producing them internally would require an investment of $1.5 million in new facilities as well as a production cost of $1,600 for each motor produced. If purchased from a vendor instead, the price would be $2,000 per motor. Michael has obtained a preliminary forecast from the company’s marketing division that 4,000 boats in this model line will be sold.

Analyze Michael’s two options. Which option should be chosen?

A. At a production point of 4000 units, Michael should choose to invest in making the boat motors in house. The total cost if he produces the motors is $7,900,000, while if he decides to buy he will pay $8,000,000.

B. Michael realizes from past experience that preliminary sales forecasts are quite unreliable, so he wants to check on whether his decision might change if a more careful forecast differed significantly from the preliminary forecast. Determine a break-even point for the production and sales volume below which the buy option is better and above which the make option is better.

The break even –point is 3.750 units. Until it reaches a 3750 production point (Q< 3750) the costs are minimized if the motors are bought from the vendor instead of producing them. If the company makes above boats 3750 (Q>3750) it is better to invest into making their own motors.

Explanation / Answer

Answer:

a.  For 4000 units sold

b.  Let the quantity at which both options have same cost be X'

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