Question: Your company has asked you to determine the financial risks of manufacturing 6,000 units of a product rather than purchasing them from a vendor at $66.50 per unit. The production line will handle exactly 6,000 units and requires a one-time setup cost of $50,000. The production cost is $60 per unit.
Your manufacturing personnel inform you that some of the units may be defective, as shown below.
% defective 0 1 2 3 4
Probability of 40 30 20 6 4
Occurrence (%)
Defective items must be removed and replaced at a cost of $145/defective unit. However, 100 percent per units purchased from vendors are defective-free.
Construct a payoff table, and using the expected-value model, determine the financial risk and whether the make or buy option is best.