A U.S Company is currently producing a product in house with a yearly fixed cost of $5 million and a variable cost of $3 per unit. A Chinese subcontractor can produce the product with equal quality for a yearly fixed cost of $3 million and a variable cost of $6 per unit.
a. What is the break-even quantity in this make-or-buy decision?
i. X = (Fin-Fout)/(Vout-Vin)
ii. X=(5m-3m)/6m-3m)=2m/3m=666,667 units
iii. X=666,667 units
b. If the expected production quantity is 1 million units, should the company make or buy? Why?
i. 1m units, the company should build. Knowing that the company will break even, the focus beyond that should be on lower variable costs which could increase, causing the break even quantity to rise. Keeping the variable costs down will increase the profit margin once beyond the breakeven point.
c. Suppose the Chinese subcontractor is willing to share the economies-of-scale benefits it might achieve in production and offers an incremental quantity discount on the variable cost. The subcontractor now charges $6 per unit for the first 0.5 million units in an order and $4 per unit for any additional units in the order. What is the break-even quantity in this case?