Question

Q 22

Suppose that a manufacturing company makes four components: A, B, C and D, for which costs in the forthcoming year are expected to be:

	A	B	C	D
Production in units	1,000	2,000	4,000	3,000
Unit variable costs	€	€	€	€
Direct materials	4	5	2	4
Direct labour	8	9	4	6
Variable production costs	2	3	1	2
	14	17	7	12

Total fixed costs per annum:

	€
Incurred as a direct consequence of making A	1,000
Incurred as a direct consequence of making B	5,000
Incurred as a direct consequence of making C	6,000
Incurred as a direct consequence of making D	8,000
Other fixed costs	30,000
Total	50,000

A sub-contractor has offered to supply units of A, B, C and D for €12, €21, €10 and €14 respectively.

Which components should the company make and which ones buy from the subcontractor? Choose the appropriate altenative for each component.

Component A : BUY or MAKE ?

Component B : BUY or MAKE ?      

Component C : BUY or MAKE ?

Component D : BUY or MAKE ?

Answer 1

	A	B	C	D
Direct material	$            4.00	$               5.00	$            2.00	$               4.00
Direct labor	$            8.00	$               9.00	$            4.00	$               6.00
Variable Production cost	$            2.00	$               3.00	$            1.00	$               2.00
Relevant variable cost per unit	$          14.00	$            17.00	$            7.00	$            12.00
Number of Units	1,000	2,000	4,000	3,000
Total Variable cost	$ 14,000.00	$    34,000.00	$ 28,000.00	$    36,000.00
add: Avoidable fixed cost	$    1,000.00	$      5,000.00	$    6,000.00	$      8,000.00
Total Relevant cost of Production	15,000.00	39,000.00	34,000.00	44,000.00
	A	B	C	D
Purchase price per unit	$ 12	$ 21	$ 10	$ 14
Number of Units	1,000	2,000	4,000	3,000
Total Purchase cost	$ 12,000.00	$    42,000.00	$ 40,000.00	$    42,000.00
Decision	BUY	MAKE	MAKE	BUY

In case of A and D Purchase cost is lower than relevant production cost so it’s better to purchase.

Although B and C has lower production cost than outsourcing price so it’s better to manufacture.

Only avoidable fixed cost will be considered for this decision and since other fixed cost would remain same whatever the decision is that is why other cost is not taken into consideration.