Kayo Computer assembles and sells personal computers. Each computer needs one custom-designed printed circuit board (PCB). Kayo has contracted to buy the PCBs from an outside PCB manufacturer, Apex Manufacturing. The one-year contract stipulates that Kayo pays $200 per board to Apex for up to 2000 PCBs. If the annual order quantity exceeds 2000 PCBs, then Apex is obligated to give a discount of $40 per board for the portion beyond 2000, thus selling them at $160.

Kayo can also buy the same PCBs from another manufacturer, TCI Electronics, that offers a lower price of $120 per PCB but asks a one-time payment of $100,000 as a nonrefundable design and engineering fee. Kayos engineers have determined that Kayo may use PCBs from either of the two manufacturers, or from both in any mixture without any manufacturing cost or compatibility problems.

The PCB along with other components are assembled by Kayo into its personal computer. The variable assembly cost of the Kayo personal computer is $450 each with an annual fixed cost of $1,500,000. Kayo sells the assembled computer for $1000 each. At the moment no one is sure how many Kayo computers the company can sell for the next year. Jenny Silk, VP of Finance at Kayo Computer, informs you that this model of Kayo computer will be discontinued after next year and so any one-time fee that might be paid to TCI must be justified base on next years sales alone. She has asked you to help her evaluate certain economic and legal issues as part of her financial plan for the next year.

Questions

1. Build a spreadsheet model that captures the profitability of the Kayo personal computer for next year. As a start, assume that 5000 computers can be sold next year and only 1000 of the PCBs are purchased from Apex (the balance being supplied by TCI).

2. If total sales were 5000 units, how many PCBs would you recommend Kayo buy from Apex and how many from TCI to maximize next years profits? (Use a Data Table 1 to help you search for your preferred recommendation).

3. In reviewing the Apex contract, you note that it requires Kayo to purchase at least 20% of the PCBs used in the Kayo computers sold (and not less than 1000 PCBs) from Apex. The contract also contains a liquidated damages clause in the event of Kayos default in the amount of $100,000. What would be the economic effect if unforeseen changes caused Kayo to default on the 20%/1000 minimum contracted purchase provision (by substituting more TCI boards) in the event that 5000 Kayo computers can be sold next year? Assuming that Apex would be open to renegotiating the contract, what new terms and/or maximum settlement amount would you recommend to Silk for her consideration in the discussion with Apex? Justify your recommendation with relevant spreadsheet exhibits.

4. A market analysis reveals that unit sales will depend on the price of the computer. At the price of $1000, about 5000 units will be sold, but for every increase (or decrease) of $100, sales will decrease (or increase, respectively) by 1000 units. Use Data Table 2 to maximize Kayos profit next year by finding (a) the optimal price and (b) the optimal number of boards to buy from Apex while still honoring the original contract.