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Good morning sir,
I just realised that there’s no lectures for sensitivity analysis. Right now, I am using Kaplan textbook but I just don’t understand the working given which I really hope you can help to explain it. I will really appreciate your help. Below is the example given:A manager is considering a make v buy decision based on the following estimates.
Variable production cost:
If made in house: $10
If but in and rebadge:$2External purchase costs:
If made in house: –
If but in and rebadge:$6Ultimate selling price:
If made in house: $15
If but in and rebadge:$14You are required to assess the sensitivity of the decision to the external purchase price.
You have not given me enough information. If it is a past exam question or a question in the BPP Revision Kit, then tell me which question it is.
I did sir. I have already double check it. This is actually an example for sensitivity analysis from Kaplan textbook. I will rewrite the example along with the working given
A manager is considering a make v buy decision based on the following estimates.
Variable production cost:
If made in house: $10
If but in and rebadge:$2External purchase costs:
If made in house: –
If but in and rebadge:$6Ultimate selling price:
If made in house: $15
If but in and rebadge:$14You are required to assess the sensitivity of the decision to the external purchase price.
The working given is;
Step 1: comparin contribution figures the product should be bought in and rebadged
If made in house : contribution is $5
If buy in and rebadge: contribution is $6Step 2: Calculate the sensitivity (to the external purchase price)
For indifference, the contribution from outsourcing needs to fall to $5 per unit. Thus, the external purchases price only needs to increase by $1 per unit. If the external purchase price rose by more than 17% the original decision would be reversedSir, I have problem to understand the step 2.
At the moment, it is better to buy in and rebadge because it results in a higher contribution ($6 instead of $5).
If the contribution from outsourcing was to change (because the external purchase price changed) then it would still be better to outsource provided the contribution remained more than $5. But if ever the contribution fell below $5 then it would be better to make in house. So we can afford the contribution from outsourcing to fall by up to $1 before the decision would change.
Since the selling price and the internal variable cost will not change, for the contribution to fall by $1 then the external purchase price would have to increase by $1.
Therefore we can afford the external purchase price to increase by up to $1 before the decision would change. It is currently $6, so an increase of $1 is an increase of 1/6 = 17%.
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