Posted on by Judy

Still concerned about the risk in Problem S11.2, suppose that Phillip is willing to use one local supplier and up to two more located in other territories within the country. This would reduce the probability of a “super-event” to .05%, but due to increased distance the annual costs for managing each of the distant suppliers would be $25,000 (still $15,000 for the local supplier). Assuming that the local supplier would be the first one chosen, how many suppliers should Witt Input Devices use now?

Data as per problem S11.2
Probability of Super-event, S = 0.5%
Probability of Unique event, U = 5%
Loss due to total shutdown, L = $ 400,000
Cost of local supplier, C1 = 15000
Marginal cost of each additional distant supplier, C2 = 25000
Expected cost with only 1 local supplier = (S + (1-S)*U1)*L + C1
= (0.5% + (1-0.5%)*5%1)*400000 + 15000
= $ 36,900
Expected cost with 1 local supplier and 1 distant supplier = (S + (1-S)*U2)*L + C1 + C2
= (0.5% + (1-0.5%)*5%2)*400000 + 15000 + 25000
= $ 42,995
Expected cost with 1 local supplier and 2 distant suppliers = (S + (1-S)*U3)*L + C1 + 2*C2
= (0.5% + (1-0.5%)*5%3)*400000 + 15000 + 2*25000
= $ 67,050
Total expected cost of only 1 local supplier is the lowest.
Therefore, Witt Input Devices should use only 1 local supplier.
 
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