Moon Micro is a small make- to order manufacturer of servers that currently builds its entire product in Santa Clara, California. The current demand and capacity are 10,000 servers per year. The annualized fixed cost is $15,000,000. Variable cost includes raw materials cost $8,000 per server and plus $500 labor per server. Moon sells each server for $15,000.
As the market for servers has grown dramatically, Moon is considering two options to increase its capacity.
§ The first option is to add 10,000 units of capacity to the Santa Clara plant at an additional annualized fixed cost of $10,000,000. Other variable costs stay unchanged.
§ The second option is to have Molectron, an independent assembler, manufacture servers for Moon at a cost of $2,000 for each server (excluding raw materials cost).
Moon must make this decision for a two-year time horizon.
§ During each year, demand for Moon servers has a 60 percent chance of increasing 50 percent from the year before and a 40 percent chance of increasing 20 percent from the year before.
§ Molectron’s prices may change as well.
They have a 50 percent chance of increasing 15 percent over each year of next two years and a 50 percent chance of remaining where they are.
Use a decision tree (with discount rate k= 0.1 for all periods) to determine whether Moon should add capacity to its Santa Clara plant without outsourcing or if it should outsource to Molectron. What are some other factors that would affect this decision that we have not discussed?