Question

Borges Machine Shop, Inc., has a 1-year contract for the production of 200,000 gear housings for a new off-road vehicle. Owner Luis Borges hopes the contract will be extended and the volume increased next year. Borges has developed costs for three alternatives. They are general-purpose equipment (GPE), flexible manufacturing system (FMS), and expensive, but efficient, dedicated machine (DM). The cost data follow:

	GPE	FMS	DM
Annual Contracted Units	$200,000	$200,000	$200,000
Annual Fixed Cost	$100,000	$200,000	$500,000
Per unit variable	$15.00	$14.00	$13.00

Which process is best for this contract?

determine the most economical volume for each process.

determine the best pro- cess for each of the following volumes: (1) 75,000, (2) 275,000, and (3) 375,000.

If a contract for the second and third years is pending, what are the implications for process selection?

Answer 1

Solution:

(a) Contracted units = 200,000

Total costs for option GPE = $100,000 + ($15 x 200000) = $3,100,000

Total costs for option FMS = $200,000 + ($14 x 200000) = $3,000,000

Total costs for option DM = $500,000 + ($13 x 200000) = $3,100,000

From the above calculations, Flexible Manufacturing System (FMS) is best for this contract, i.e., for the production units of 200,000 gear housings at a total cost of $3,000,000.

(b) Using the break-even analysis, the most economical volume for each process is given as;

Let the contracted units = x

(i) $100,000 + $15x = $200,000 + $14x

x = 100,000

The option GPE is best when the contracted volume is between 0 and 100,000 units.

(ii) $200,000 + $14x = $500,000 + $13x

x = 300,000

The option FMS is best when the contracted volume is between 100,000 units and 300,000 units.

The option DM is best when the contracted volume is above 300,000 units.

(c) From the above calculations, we can determine that;

At 75,000 units, GPE is the most economical and best process.

At 275,000 units, FMS is the most economical and best process.

At 375,000 units, DM is the most economical and best process.

(d) If a contract for the second and third years is pending, the total production volume for the production units will be equal to 600,000 units (200,000 per year x 3 years). For the production of 600,000 units, DM would be the most economical and best process.