Run Company produces a variety of products in its large production facility. The company uses a just-in-time

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Run Company produces a variety of products in its large production facility. The company uses a just-in-time approach and only keeps about four hours' worth of inventory of all input materials. The company uses its reputation for reliable on-time delivery and flexibility as a competitive weapon and charges a premium price for its products because of its service capabilities. The company's current on-time delivery rates are above 99% each month. Run Company management estimates that the net present value of this reputation effect (at the company's risk- adjusted weighted-average cost of capital of 10%) is $20 million. Run Company has a marginal corporate tax rate of 25%.

Run Company currently makes 100,000 units each year of Part DMC for use in other products. It can continue to make the part in-house or buy it from Jay Corporation for $45 per unit. Jay Corporation has a reputation for making high-quality parts and delivering on-time with reliability about 90%. Part DMC will be viable for the foreseeable future, as it is a versatile component in many products.

If Run Company outsources (purchases) Part DMC, the company can avoid only 25% of the fixed costs associated with the part. Run Company's data for in-house production of Part DMC are:

Direct Materials $30 per unit Direct Labor 19 Variable Overhead 11

Fixed Overhead 20

Total $80 per unit

Run Company's management team has determined that the next best opportunity for growth lies in improving the time it takes the company to develop, test, and launch new products. If Run Company chooses to outsource Part DMC, it can reconfigure the now-idle factory space into a small "pilot plant" that can produce small quantities of different products and prototypes quickly and with much flexibility.

What is the that Run Company's management must place on the in-house pilot plant in order that the decision to outsource Part DMC has benefits greater than its costs?

Show explicitly any calculations that you make and state explicitly any assumptions you make.