Your company is trying to reduce supply-chain costs. There is one component that you are currently purchasing for $20 per unit. Your manufacturing unit has said that they could make the component in-house at a cost of $5 per unit. However, there would be significant fixed costs of $200,000 for manufacturing equipment. The equipment has an expected lifetime of five years, with a salvage value equal to 10% of its original costs at the end of year 5. Your company has a discount rate of 10%/year.
(a) Determine the break-even quantity (i.e., how many components you would need to make per year, over the five-year lifetime of the equipment, in order to be indifferent between making and buying the component).
(b) If the company uses 5,000 of these components per year, should they make or buy them?