Question

Rally, Inc. produces the Mayhem Raider, an all-terrain utility vehicle. It currently purchases the Mayhem Raider's engine from a supplier but is considering making the engine in-house. The firm produces 100 engines per month.

Cost to buy: $5,000 per engine.

Cost to make: $300,000 in machinery and labor cost per month. $210,000 in other costs per month.

The Mayhem Raider is at the early stages of its product life cycle. Making the engines in-house should allow the firm's to have better long-term control over this product over and can lead to significant cost efficiencies in the future.

Which of the following is TRUE?

a. Both relevant cost analysis and strategic cost analysis suggest the firm should make.
	b. Relevant cost analysis suggests the firm should make, but strategic cost analysis suggests the firm should buy.
	c. Relevant cost analysis suggests the firm should buy, but strategic cost analysis suggests the firm should make.
	d. Both relevant cost analysis and strategic cost analysis suggest the firm should buy.

Answer 1

Solution:

Relevant cost analysis is all about comparing the costs of both alternatives and selecting the beneficial one:

Cost of Buying 100 engines = $5000 * 100 = $500000

Cost of Making 100 engines = $300000 + $210000 = $510000

It looks like making engines is costlier by $10000 ($100 per engine) than buying engines. Hence, relevant cost analysis suggests that firm should buy engines instead of making them.

But things are not always this simple. Making product in-house can have several advantages over time (reduced dependency on outside manufacturer, better customer satisfaction, in-house research and development, economies of scale with increasing turnover, reduced per unit cost with increasing turnover, etc.). Firm is still in initial stage of its product life cycle. Strategic cost management covers this area with taking into account additional variables and taking informed decisions accordingly. In a favorable scenario, with increase in level of activity and efficiency over time, firm can actually be better off making the engines in-house.

Hence, answer in this problem would be:

c. Relevant cost analysis suggests the firm should buy, but strategic cost analysis suggests the firm should make.