A critical component of Cheep Corporation’s uPod MP3 playback device is the LQX-909 microchip. Cheep uses 10,000 of this component annually at a uniform rate. Currently, this part is purchased from an external supplier at a cost of $12.00/unit. Cheep’s inventory holding cost rate for all electronic components is $0.30/unit/year and the fixed ordering cost for the LQX-909 chip is $60/order.

Mary Kendell, Cheep’s VP of Operations, is investigating the possibility of producing the LQX909 chip within the company’s batch-production fabrication facility. She estimates that this item can be manufactured internally at a rate of 25,000 units/year and its total unit variable production cost would be $11.80. Mary, however, is unable to estimate the fixed setup cost of producing a batch of the LQX-909 chip, at this time.

(a) What is the maximum allowable cost per setup for this item, so that it would be economically more desirable to fabricate it in-house, rather than purchasing it from the current supplier?

(b) After a lengthy period of study, Mary has determined that the fixed setup cost/batch for producing the LQX-909 microchip would be $265 per batch. In the meantime, the supplier of this item has offered a quantity discount plan, which reduces the cost of this chip from $12 to $11.75 a unit, if it is purchased in lots of 2,000 or more at a time. In view of this, should Cheep continue to purchase this item from the supplier, or should it be produced in-house? What would be the lot size and the annual total relevant cost, resulting from the company’s optimal decision (make or buy) concerning the LQX-909 microchip?