Tutorial 4: Decision Trees [10 pts]

COM 4OD3 Winter 2016

Purchasing and Supply Management
E. Hassini

Due Tuesday February 2, 2016 at at time of

Tutorial

Note: You should attend the tutorial and do the activity in order for your mark to count. Late
submissions after the tutorial will not be marked. You will be provided with an answer form (see next
page) where you can fill in your answers during the tutorial.

Trip 7 Screen (Case covered in Tutorial 3) has reached its printing capacity (Steps 8 and 9) of
10,000 t-shirts per year. The company is considering two options to increase capacity: (1) add 10,000
units of capacity to its Columbus plant at an annualized fixed cost of $100,000 plus $5 labour per
shirt, or (2) subcontract to T52, an independent all-purpose printing services, to print t-shirts at a
cost of $17 for each t-shirt (excluding raw materials cost). Raw materials cost are $5 per shirt, and
Trip 7 sells each t-shirt for $30. Trip 7 must make this decision for a two-year time horizon. During
each year, demand for Trip 7 t-shirts has an 80 percent chance of increasing 50 percent from the year
before and a 20 percent chance of remaining the same as the year before. T52 prices are fixed for the
first year but have a 50 percent chance of increasing 20 percent in the second year and a 50 percent
chance of remaining where they are.
1. Use a decision tree to determine whether Trip 7 should add capacity to its Columbus plant or
if it should outsource to T52. Assume the discount rate is 0.1. We will build the decision tree
together in the tutorial and you will work out the net present values to determine the right
sourcing decision.
2. What is the minimum amount that T52 should charge for the company to reverse its make-orbuy decision?
3. Procurement is trying to convince the subcontractor to fix the price in year 2 at $18.2 (a 7%
increase). This would allow them to eliminate the uncertainty on the cost of subcontracting.
What is the value of having this perfect information on costing in the second year? After
negotiation with the subcontractor they agreed to fix the price in year 2 at $18.2 on the condition
that the company pays an additional lump sum amount of $4,300. Is it still attractive to fix
the prices?
4. The company is considering the adoption of dual sourcing policy: 70% inhouse (after opening
a new plant in Columbus) and 30% outsources. What is the additional cost of this dual policy
(over the solution found in part 1)?

Answer form:

FS-28
Pauline Varona
Name: ........................................................................
ID: .....................................
$416, 363
1. Profit from expansion: ...........................................
$468, 800
Profit from subcontracting: ...........................................
2. The minimum amount that T52 should charge for the company to reverse its make-or-buy
$22.46
decision is .......................................

$4364
3. The value of having perfect information on pricing in the second year is ..................................
X or no .......
Accept lump sum amount of $4,300: yes ......
$40, 942
4. The loss in profit from this dual policy is ..........................................