Question

One of your Taiwanese suppliers has bid on a new line of molded plastic parts that is currently being assembled at your plant. The supplier has bid $0.10 per part, given a forecast you provided of 200,000 parts in year 1; 400,000 in year 2; and 500,000 in year 3. Shipping and handling of parts from the supplier’s factory is estimated at $0.03 per unit. Additional inventory handling charges should amount to $0.005 per unit. Finally, administrative costs are estimated at $30 per month.

Although your plant is able to continue producing the part, the plant would need to invest in another molding machine, which would cost $20,000. Direct materials can be purchased for $0.06 per unit. Direct labor is estimated at $0.05 per unit for wages plus a 50 percent surcharge for benefits and, indirect labor is estimated at $0.009 per unit plus 50 percent benefits. Up-front engineering and design costs will amount to $30,000. Finally, management has insisted that overhead be allocated if the parts are made in-house at a rate of 100 percent of direct labor wage costs. The firm uses a cost of capital of 15 percent per year.

a. Calculate the difference in NPVs between the Make and Buy options. Express all costs as positive values in your calculations. It is suggested to use the NPV function in Excel. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

(Difference in NPV $

b. Should you continue to produce in-house or accept the bid from your Taiwanese supplier?

Answer 1

Answer a)

NPV of cost for buy option from Taiwanese supplier

Column 1	Column 2	Column 3	Column 4	Column 5	Column 6	Column 7	Column 8	Column 9
Buy option	Number of units supplied	Bid price for parts at $0.10 per Unit (Col 2*0.10)	Shipping and Handling Cost at $0.03 per unit (Col 2*0.03)	Additional Inventory Handling cost at $0.005 per unit (Col 2*0.005)	Administration Cost at $30 per month (12*30)	Total Cost (Col 3+4+5+6+7)	Discounting factor (1+r)^n value at 15% (n=1,2,3)	NPV (Col 7/Col 8)
Year1	200,000	20,000	6,000	1,000	360	27,360	1.15	23,791.30
Year2	400,000	40,000	12,000	2,000	360	54,360	1.32	41,103.97
Year3	500,000	50,000	15,000	2,500	360	67,860	1.52	44,619.05
Total Cost								109,514.33

NPV of cost for Make option

Column 1	Column 2	Column 3	Column 4	Column 5	Column 6	Column 7	Column 8	Column 9	Column 10
	Number of units to be produced	Investment cost in the beginning	Engineering and design cost in the beginning	Raw material cost at $0.06 per unit (Col 2*0.06)	Direct labor cost at $0.05*150% per unit (Col2*0.075)	Indirect labor cost at $0.009*150% per unit (Col2*0.0135)	Total Cost (Col 2+3+4+5+6+7)	Discounting factor (1+r)^n value at 15% (n=1,2,3)	NPV (Col 8/Col 9)
Day0		20,000	30,000				50,000	1	50,000
Year1	200,000			12,000	15,000	2,700	29,700	1.15	25,826.09
Year2	400,000			24,000	30,000	5,400	59,400	1.32	44,914.93
Year3	500,000			30,000	37,500	6,750	74,250	1.52	48,820.58
Total Cost									169,561.60

Hence. the difference in NPV of Make and Buy options=$ 169,561.60-$109,514.33=$60,047.28

Answer b) Since NPV of In-house make option is more than Buy option, we should opt for acceptance of bid from Taiwanese Supplier.