Chapter 5, Problem 71P

Learning Curves (Appendix B)

Krylon Company purchases eight special tools annually from CO., Inc. The price of these tools has increased each year, reaching $100,000 per unit last year. Because the purchase price has increased significantly, Krylon management has asked for a cost estimate to produce the tools in its own facilities.

A team of employees from the engineering, manufacturing, and accounting departments has prepared a report for management that includes the following estimate to produce the first unit. Additional production employees will be hired to manufacture the tools. However, no additional equipment or space will be needed.

The report states that total incremental costs for the first unit are estimated to be $120,000, as shown here:

Overhead and administrative costs are not affected by producing this tool.

The current purchase price is $100,000 per unit, so the report recommends that Krylon continue to purchase the product from CO., Inc.

Required

Assume that Krylon could experience labor-cost improvements on the tool production consistent with an 80 percent learning curve. Should Krylon produce or purchase its annual requirement of eight tools? Explain your answer. (Note that the 80 percent learning rate coefficient is −0.3219.)