Question

Structuring a Make-or-Buy Problem Fresh Foods, a large restaurant chain, needs to determine if it would be cheaper to produce 5,000 units of its main food ingredient for use in its restaurants or to purchase them from an outside supplier for $12 each. Cost information on internal production includes the following: Total Cost Unit Cost Direct materials $25,000 $ 5.00 Direct labor 15,000 3.00 Variable manufacturing overhead 7,500 1.50 Variable marketing overhead 10,000 2.00 Fixed plant overhead 30,000 6.00 Total $87,500 $17.50 Fixed overhead will continue whether the ingredient is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price. Required: 1. What are the alternatives for Fresh Foods? 2. List the relevant cost(s) of internal production and of external purchase. 3. Which alternative is more cost effective? By how much? $ 4. Now assume that 20% of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost effective? By how much? $

Answer 1

1. Two available alternatives are- Purchase it externally or In Restaurant

2. Relevant costs of making the component in-house consist of direct materials, direct labor, and variable overhead. Relevant costs includes the purchasing the component externally inclusive of the purchase price

　

3. Solution: Make in Restaurant; $ 2,500

Working:

ALTERNATIVE : BUY
Cost (12 *5000 units)	60,000
Fixed cost	30,000
Total cost	90,000
ALTERNATIVE : MAKE
Direct materials	25,000
Direct labor	15,000
Variable manufacturing overhead	7,500
Variable marketing overhead	10,000
Fixed plant overhead	30,000
Total	87,500
Difference (90,000 - 84,000)	2,500

　

4. Solution: Purchase from externally; $3,500

Working:

ALTERNATIVE : BUY
Cost (12 *5000 units)	60,000
Fixed cost (30,000*80%)	24,000
Total cost	84,000
ALTERNATIVE : MAKE
Direct materials	25,000
Direct labor	15,000
Variable manufacturing overhead	7,500
Variable marketing overhead	10,000
Fixed plant overhead	30,000
Total	87,500
Difference (87,500 - 84,000)	3,500