Capstick Limited is a medium sized company employing 300 people that was established 30 years ago by the present Chairman, John Smith. The organisation and key individuals are described in figure 1. John is an engineer and takes a great interest in the technical challenges faced by his company, and who has built his business based on a close relationship with his customers where he has endeavoured to support his design creativity with the ability to control directly the manufacturing quality. The company manufactures automotive components for major tier one suppliers to the car manufacturers and is constantly under price and quality pressure. The components are machined alloy castings, with pressed in bearings and shafts and perform a critical function in a car engine. The company owns the technology inherent in the product, although the customer specifies the design specification and mating dimensions. One major customer has demanded that the products be reduced in price from £18 to £15 each, although he is prepared to negotiate a 5-year contract to take these products at a rate of 100000 per year at this new price. If the company continues to charge more than £15, the customer, depending on the price, is likely to take their business elsewhere. There is therefore a risk that the 100000 units sold each year will cease to be ordered. The company currently manufactures the products on a ‘semi-automatic’ production line, which, if the business were lost, would cost £85k to close down. In addition the Company has recently specified and received a quote for a fully automated line that will offer significant cost savings.

The product cost breakdown is as follows:

Cost of manufacture, current production methods: £16
Cost of manufacture, automatic operation: £13

The current production equipment is written off, so there are no depreciation costs, however, there are maintenance costs of £10k per year, with an attendant risk, estimated at 30% in 5 years, of a major breakdown costing £50k to rectify.

The proposed new automated equipment will cost £500k, paid after commissioning and funded by money from the Company’s investment account where it receives 15% per year growth. The company policy is to depreciate such equipment to zero over 5 years so that it would have no residual worth after 5 years. Any breakdowns will be subject to warranty cover over the first three years and this is included in the price: subsequent maintenance charges will be £20k and £30k in years 4 and 5 respectively.

The Company has estimated the risks of the customer taking their business elsewhere as follows:

Unit price: £15 £16 £17 £18
Risk: 0 30% 70% 100%

The Company also came up with an alternative strategy: to close the present facility and to sub-contract the manufacture of the products. It obtained a quotation for this at £15.50 per unit for 100000 units per year for 5 years.

1.(a)Without introducing the proposed automated production equipment and using decision tree principles, recommend a unit price to quote the customer based on greatest benefit to the Company and calculate the expected value of the decision. (b)Compare the in-house manufacture and the sub-contracted routes.