A manufacturer of military jets is considering a move to outsource the engines r
ID: 432561 • Letter: A
Question
A manufacturer of military jets is considering a move to outsource the engines required in their planes. Two engineering contractors are capable of producing these engines (in addition to the company in question). Using the data given below, compute the annual cost for each option (to make or buy) and determine which one is preferable if cost is the only consideration. Assume that there is a demand of 45 jets per year. (Also note that a fixed cost from a contractor could indicate a retainer fee, or an administrative charge to cover the contractor's new fixed costs for a particular contract.) Variable cost per jet (Sthousands)950 Annual fixed cost (Sthousands) 4,650 35,000 5,750 200,000Explanation / Answer
Solution
Annual demand of jets = 45 jets per year
(a) Total annual cost of making the jets is calculated as,
Total annual cost = Annual fixed cost + (Variable cost per jet x Number of jets)
Putting the given values in the above formula, we get,
Total annual cost = $200,000 + ($950 x 45)
Total annual cost = $242,750 thousands
(b) Total annual cost of buying jets from Contractor A is calculated as,
Total annual cost = Annual fixed cost + (Variable cost per jet x Number of jets)
Total annual cost = 0 + ($5,750 x 45)
Total annual cost = $258,750 thousands
(c) Total annual cost of buying jets from Contractor B is calculated as,
Total annual cost = Annual fixed cost + (Variable cost per jet x Number of jets)
Total annual cost = $35,000 + ($4,650 x 45)
Total annual cost = $244,250 thousands
Conclusion: If cost is the only consideration, then the company should make jets in-house owing to the lowest total annual costs among the given three alternatives.
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