Question

please use excel to answer the following question.

A company must decide whether to manufacture a component part at its Michigan plant or purchase the component part from a supplier. The resulting profit is dependent upon the demand for the product. The following payoff table shows the projected profit (in thousands of dollars) and includes the (prior) probabilities of the demand (assuming no test market study). Low Deman 36% $20 $10 man Demand Probabilities Manufacture yourself Purchase from vendor 35% $40 $45 30% $100 S70 A test market study of the potential demand for the product is expected to report either a favorable (F) or unfavorable (U) business conditions. The conditional probabilities of the test are as follows: Probability of Test Market Results given the demand 1096 eman ar Favorable Unfavorable 40% 60% 60% 40% 90% 1. What is the optimality strategy for the company W.r.t, doing the test market study and the decision of whether to manufacture or purchase? 2. What is the maximum amount that the company should pay to do the test market study? 3. What is the Efficiency of the information gained by doing a market survey?

Answer 1

Statement of variable cost:-	"all fig are in thousands of $
Assuming	At 100% capacity level plant able to make 100 units @$100
		Low	Medium	High		Low	Medium	High
	Demand probabilities	35%	35%	30%		35%	35%	30%
	Manufacture yourself					Purchase Outside
	Favorable	10%	40%	60%		10%	40%	60%
	Sale	3500	3500	3500.00		3500	3500	3500.00
Less	Variable Cost	3700	3400	3333.33		3400	3387.5	3383.33
	Contribution	-200	100	166.67		100	112.5	116.67
Less	Fixed Cost	-180	60	66.67		90	67.5	46.67
	EBITDA	-20	40	100.00		10	45	70.00
	Un-Favorable	90%	60%	40%		90%	60%	40%
	Sale	3500.00	3500.00	3500.00		3,500.00	3,500.00	3,500.00
Less	Variable Cost	3522.22	3433.33	3250.00		3,488.89	3,425.00	3,325.00
	Contribution	-22.22	66.67	250.00		11.11	75.00	175.00
Less	Fixed Cost	-2.22	26.67	150.00		1.11	30.00	105.00
	EBITDA	-20.00	40.00	100.00		10.00	45.00	70.00
Answer Point 1	IF demand is high then company should manufacture at own because at high demand Variable cost to make is low and profit is higher shown in above table optimal level is 30% high demand for own production
Answer Point 2	The maximum amount should not be higher then variable cost for high demand it is not more then $3520
Answer Point 3	The efficiency we gain by market survey is analysis of variable cost at different level of Market demand shown as with trend of cost change at various level of capacity and when to make or buy outside is depending factor on variable cost that we bear.