To: Mr. Frame
CC: Larry DuCharme
From: Jason Kee
Subject: Review of the Make-Or-Buy Decision for 878 Aircraft
As per our conversation last week, I have calculated the cost estimates you requested regarding whether we should manufacture the new 878 body sections ourselves or purchase them from the Japanese supplier. Based on the information given to me by the various departments involved, I have come to a conclusion that it would be to our advantage to produce the body sections ourselves rather than outsource the product. My assumptions, method of calculations, quantitative and qualitative analysis and my reflection of the results are provided below. Assumptions
In reaching my conclusion, I have made the following assumptions. 1.
We will have a 30% tax rate and we will be profitable in both scenarios. 2.
The total cost of capital is $14,000,000.
The relationship between MOH and labor hours is the same as comp. wing mfg. 4.
The inflation rate will be 3.25% each year.
All calculations are in US dollars.
A learning curve is at 90% with a minimum # of hours reached per batch being 1,400 hours. 7.
Cash flows occur at the end of each year.
In order to evaluate the production decisions, I have elected to look at the present value of future cash flows over a ten year period. Results
Based on the model shown in the attachment provided, the PV of producing the body sections is $262,170,179 compared to $340,422,049 if production is outsourced to a Japanese supplier. It should be noted that the cost of the body parts are mainly composed of materials costs. Labor costs only account for about 2 to 3% of total costs.
Initial cash out flows are higher in the build our own scenario because of the upfront capital investment required. However, by the end of year three, cumulative cash outflows are higher in the purchase scenario. Other considerations
Aside from my quantitative analysis, I have also considered many...
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