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Payoff Table and Financial Risks

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Determine the financial risks of manufacturing 6,000 units of a product rather than purchasing them from a vendor.

Manufacture = $50,000 one-time set up cost + $60/unit

% defective 0% 1% 2% 3% 4%

Probability
of occurrence (%) 40% 30% 20% 6% 4%

Cost to replace defectives = $145

Purchase = $66.50/unit, 100% defect free

Construct a payoff table, and using the expected-value model, determine the financial risk and whether the make or buy option is best.

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Solution Summary

This solution prepares a payoff table and uses the expected-value model to determine the financial risk and if the make or buy option is best for the company. All steps are shown in an Excel file.

Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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