An industrial firm can manufacture several lines of pressure washers. The demand for a particular component required for a pressure washer is 120,000 per year. The firm has the following two options:
Buy option: A supplier is willing to provide this component at a unit sales price of $35.000, if at least 100,000 units are ordered annually.
Make option: The machine that can be used to manufacture this component costs $2,200,000 now and will have a salvage value of $120,000 after five years. The manufacturing cost per unit including the direct material and labor and the variable and fixed factory overhead is only $30.00. In addition, the annual maintenance cost of the machine is $100,000.
Calculate the unit under each of the above two options and choose the best option. Assume that the firm’s interest rate is 12%, compounded annually.