Quentin Company manufactures a thermostat designed for effective climactic control of large buildings. The thermostat requires a specialized thermocoupler, purchased from Cosmic Company at $15 each. For the past two years, an average of 10% of the purchased thermocouplers have not met quality requirements; however, the rejection rate is within the range agreed on in the purchase contract.
The company has most of the facilities and equipment needed to produce the components. Additional annual fixed cost of only $32,500 would be required. The Engineering Department has designed a manufacturing system that would hold the defective rate to 4%. At an annual demand level of 18,000 units, engineering estimates of the probabilities of several variable manufacturing unit costs, including allowance for defective units are as follow:
Estimated Variable Cost per Unit Probability
$10 ....................................................1
12 ....................................................3
14 ....................................................4
16 ....................................................2
Required:
Prepare a make-or-buy decision analysis using the probability distribution estimates.