Dilaware Pipe: Make or Buy?

Question 2(a):

What is the opportunity cost (sacrifice) of using two workers to produce the 10-in. and 12-in. pipe internally?

Answer:

One opportunity for the firm is to start the project and if it does the workers will not remain overstaffed and the company will not bear any opportunity cost for them.

Second opportunity for the firm is not to start the project. If it does not start the project then the two workers will lay off at most for three years and company has to bear their cost in terms of their annual wages. At the same time, the company is also expecting that their sales will be increase in three years and these workers will be deployed anyways. Moreover, two of the workers will be retired after 3-years and these two workers can take place of them. By keeping all these points in mind, if the company does not start the project , it will bear the opportunity cost in terms of paying wages to the two workers.

The annual wage for one worker is $20,000 and for two workers it will be $ 40,000. Note that Walker (the owner of the company) expects that there is a 20% chance that these workers will be employed in the new project. Therefore for one worker we will take 20% cost of the total annual cost, which is $20,000 x 0.20 = $4,000 and for two workers it will become $8,000 ( $4,000 x 2). For three years it will become $24,000 ($8,000 x 3). Therefore, the total opportunity cost for these two workers borne by the company if the project is not undertaken would be $ 24,000 for three years.

Question 2(b):

How, if at all, should the items in Exhibit 2 be adjusted to get the incremental cash flows of the project? Be as specific as possible for each item using financial theory, information provided in the case, and the sales projected in Exhibit 1. And keep in mind that you only want to consider those items that will change if the project is implemented.

Answer:...