The Sourcing Decision at Riverside Crafts

Riverside Crafts is a manufacturer of recreational boats that currently builds its entire product in Mobile, Alabama. As the market for its products has grown, the Mobile plant has reached capacity of 5,000 boats per year. Riverside is considering two options to increase its capacity. The first option is to add 5,000 units of capacity to the Mobile plant at an annualized fixed cost of $5 million plus $250 labor per boat. The second option is to have EZ Boats, an independent company, manufacture boats for Riverside at a cost of $1,000 for each boat (excluding raw materials cost). Raw materials cost $4,000 per boat, and Riverside sells each boat for $7,500.

Uncertainties Faced by Riverside Crafts

Riverside must make this decision for a two-year time horizon. During each year, demand for Riverside Boats 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. EZ Boats prices may change as well. They 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.

Study Questions

1. Draw a decision tree to determine whether Riverside should add capacity to its Mobile plant or if it should outsource to EZ Boats.
2. What is the NPV of expected profit over the next two periods for each of the two choices? Assume a discount factor of k = 0.1 per period.
3. What are some other factors that we have not discussed that would affect this decision?