Question

You are given the following information:

Costs	Make Option	Buy Option
Fixed Cost	SAR 62500	SAR 2500
Variable Cost	SAR 7.5	SAR 8.5

1. Find the break-even quantity and the total cost at the break-even point.
2. If the requirement is 75000 units, is it more cost-effective for the firm to buy or make the components? What is the cost savings for choosing the cheaper option?

Answer 1

Let .......... X be number of units representing break even quantity between the two options. A break-even quantity in this context means the number of units of sale at which both options will cost same to the organization.

Cost equation ( Make option ) = 7.50 * X units + 62500... ( i.e variable cost + fixed cost )

Cost equation ( Buy option ) = 8.5 * X units + 2500

To solve for X, equate the above two equations......... 7.5 * X + 62500 = 8.50 * X + 2500

8.50 * X - 7.50 X = 62500 - 2500

X = 60,000 Units

Total cost at Break-even point = 7.50 * 60000 + 62500 = 512500 ( make option)

OR ......... 8.50 * 60000 + 2500 = 512500 ( Buy option)

Question - (b)

If the requirement is 75000 units, it is a situation where demand exceeds the break - even point. Hence make option with high fixed cost and low variable cost is more cost-effective.

Cost saving = Saving in variable cost - Additional fixed cost

= 75000 * ( 8.50 - 7.50 ) - 60000

= 75000 - 60000

= 15000