Question

Make versus buy

You make refrigerators. Currently, you manufacture compressors for your refrigerators in-house. An outside supplier has offered to sell you equivalent compressors at a wholesale price of $105 per unit. You need 1,000 compressors per month. The internal production costs per compressor are as follows:

	cost per unit
direct materials	$40
direct labor	$40
variable overhead	$20
fixed overhead	$30
total	$130

If you outsource the production of compressors (the buy option) in the short term, how will this choice affect your costs and profit?

First, compute variable costs under MAKE versus BUY:

	MAKE	BUY
unit VC
total VC

If you outsource (BUY), the incremental revenue, costs, and profit are:

	how much each amount changes if you outsource
Incremental revenue
Incremental VC
Incremental CM
Incremental FC
Incremental profit

Enter negative amounts with a minus sign, i.e., -1,000 not ($1,000).

Answer 1

• Requirement 1

	MAKE	BUY
unit VC	$             100.00 [ 40 + 40 + 20]	$          105.00 [Purchase price]
total VC [Unit VC x 1000 units]	$       100,000.00	$    105,000.00

• Requirement 2

	how much each amount changes if you outsource
Incremental revenue	$                    -
Incremental VC [105000 – 100000]	$          5,000.00
Incremental CM	$         (5,000.00)
Incremental FC	$                    -
Incremental profit (loss)	$            (5,000.00)