Question

1. A Las Vegas, Nevada manufacturer has the option to make or buy one of its component parts. The annual requirement is 20,000 units. A supplier is able to supply the parts for $10 each. The firm estimates that it costs $600 to prepare the contract with the supplier. To make the parts in-house, the firm must invest $50,000 in capital equipment and estimates that the parts cost $8 each. Assuming that cost is the only criterion, use break-even analysis to determine whether the firm should make or buy the item. What is the break-even quantity, and what is the total cost at the break-even point?

Answer 1

Annual requirements = 20000 units

Buying price from the supplier = $10 per unit

Contract preparation cost = $600

Hence total cost of buying = buying price*units + contract preparation cost

= 10*20000 + 600

= 200000 + 600

= $200600

Annual requirements = 20000 units

Fixed investment to make it = $50000

Cost per unit = $8

Hence total cost of making = fixed cost + units*cost per unit

= 50000 + 8*20000

= 50000 + 160000

= $210000

Hence the firm should buy it from the supplier. (as it has lower cost)

Break even point:

Breakeven point is that point where the cost for both the options (making and buying is same)

Let the quantity = x

Buying cost = 10*x + 600

Making cost = 50000 + 8*x

As both cost is same

10*x + 600 = 50000 + 8*x

10*x – 8*x = 50000 – 600

2*x = 49400

x = 24700

Hence at 24700 units, both the option will have same quantity.

Cost at breakeven = cost of making 24700 units = cost of buying 24700 units

= 10*24700 + 600

= 247000 + 600

= $247600

Breakeven quantity = 24700

Breakeven cost = $247600

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