Read the information below about Northshore Components. This business supplies replacement electric motor controllers to repair workshops. Its manager has r...
Question 1 Report
Read the information below about Northshore Components. This business supplies replacement electric motor controllers to repair workshops. Its manager has received an order opportunity from a regional vehicle-maintenance chain. The business must select one of two options. It can purchase specialist testing equipment and assemble the controllers in its own workshop, or it can outsource assembly to another producer.
Fig. 1 is a decision tree created after the manager spoke to employees, customers and a supplier. The figures at the ends of the branches are estimated annual profits, after all relevant costs have been deducted. The probabilities show the manager's estimate of demand being high or low. The manager has looked at businesses such as Huawei and Tata Motor when judging whether the estimates are realistic.
Fig. 1 Decision tree for Northshore Components
(a) State what is meant by a decision tree. [2]
(b) Calculate the expected annual profit for each option shown in Fig. 1. Show your working. [4]
(c) State which option Northshore Components should select if the decision is based only on expected annual profit. [1]
(d) Explain one reason why the manager should consider information other than the expected annual profit before making the decision. [3]
(e) Analyse whether Northshore Components should buy the equipment and assemble the controllers in-house. Give a justified answer. [10]
Answer Details
(a) A decision tree is a diagram or model showing possible business choices and their possible outcomes. It includes the probabilities or likelihoods of outcomes and their financial results. [2]
(b) Expected annual profit
Buy equipment and assemble in-house:
\[(0.65\times£90,000)+(0.35\times£20,000)=£58,500+£7,000=£65,500\]
Outsource assembly:
\[(0.80\times£45,000)+(0.20\times£15,000)=£36,000+£3,000=£39,000\]
The expected annual profits are £65 500 for in-house assembly and £39 000 for outsourcing. [4]
(c) If the choice is based only on expected annual profit, Northshore Components should buy the equipment and assemble controllers in-house, because £65 500 is higher than £39 000. [1]
(d) Why information beyond expected profit is needed: the probabilities are estimates, so actual demand may differ from the manager's forecast. If those probabilities are inaccurate, the expected profit may not occur and a decision based only on the tree could be unsuitable. [3]
(e) Whether Northshore should buy equipment and assemble in-house
In-house assembly has the higher expected annual profit, £65 500 compared with £39 000. This higher return could provide funds for growth. It also gives Northshore greater control over quality and delivery times, which can protect its reputation with repair workshops. Employees may gain technical skills, and Northshore becomes less dependent on an outside producer.
However, specialist equipment may require a large initial payment, causing cash-flow difficulties. The decision tree shows that low demand would produce only £20 000 profit for in-house assembly. Outsourcing avoids purchasing and maintaining machinery and may be more flexible if the regional order ends. However, late deliveries or poor supplier quality could damage customer relationships.
Northshore should choose in-house assembly if it can afford the equipment and has suitably trained employees, because its expected annual profit is substantially higher and it gains quality control. If finance is limited or demand estimates are particularly uncertain, outsourcing can be justified as the lower-risk, more flexible alternative. Developed analysis and a supported judgement earn up to [10].
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