The Gallant Company manufactures a unique thermostat that yields dramatic cost savings from effective climatic control of large buildings. The efficiency of the thermostat is dependent upon the quality of a specialized thermocoupler. These thermocouplers are purchased from Braun Company for $15 each.
Since early 2003, an average of 10% of the thermocouplers purchased from Braun has not met Gallant’s quality requirements. The number of unusable thermocouplers has ranged from 5% to 25% of the total number purchased and has resulted in failures in meeting production schedules.
In addition, Gallant has incurred additional costs to replace the defective units because the rejection rate of the units is within the range agreed upon in the contract.
Gallant is considering a proposal to manufacture the thermocouplers. The company has the facilities and equipment to produce the components. The engineering department has designed a manufacturing system that will produce the thermocouplers with a defective rate of 4% of the number of units produced. The following schedule presents the engineer’s estimates of the probabilities that different levels of variable manufacturing cost per thermocoupler will be incurred under this system. Additional annual fixed costs incurred by Gallant, if it manufactures the thermocoupler, will amount to $32,500.
Estimated Variable Manufacturing Cost Per Thermocoupler Unit
Probability Of Occurrence
$10
.1
$12
.3
$14
.4
$16
.2
Gallant Company will need 18,000 thermocouplers to meet its annual demand requirements.
Required:
Prepare an expected value analysis to determine whether Gallant Company should manufacture the thermocouplers.