Question

In a make or buy case we have the following:

- Cashflow for 5 years ( both fixed and variable costs "direct labor, direct materia, MOH" are available in the statement )

- NPV was already calculated

- $POHR was also calculated

- Income is not available ( it is not possible to assume it )

What other financial calculations can be taken into consideration to support the make or buy decision ?

1) Please specify the methods

2) Do you think $POHR calculation really affect the make or buy decision ?

Thanks in advance !

Answer 1

(1) Marginal costing method is helpful to take make or buy decision.

Marginal costing helps management to decide whether the firm should itself manufacture a product or buy from outside.

Marginal costing is very helpful for management in decision making between two alternatives.

For taking make or buy decision we need to know cost of buying and cost of manufacturing of product. We should thoroughly analyze the cost associated with production and associated with buying the product

.It will considered relevant cost only, irrelevant cost will be ignored .

Relevant cost means cost that is relevant for decision ,relevant cost is a cost that is caused by the decisions that will be incurred in the future and different for different alternatives.

e.g. opportunity cost, avoidable cost, incremental cost,future cash flow etc.

Irrelevant cost means cost that would not be affected by a management decision because they cannot be changed such as fixed overhead/cost, sunk cost etc.

Cost associated with production is : direct materials, direct labour and variable manufacturing oerhead

Cost associated with buying is: purchase price, transportation cost, sales tax, procurement cost, carrying cost etc.

Accurate information and thoroughly analysis of these costs help to take make or buy decision, if total cost of manufacturing is below from cost of buying then we'll make the product and vice-versa.

(2) Yes, POHR i.e. predetermined overhead rate affect make or buy decision .

To calculate cost of production POHR is first step . predetermined overhead cost is determined in advance based on variable and fixed cost.

It is caculated by dividing estimated manufacturing overhead cost / estimated total units

Using POHR helps company planners to form strategies and to take decision, because company would not be able to determine actual cost until production has actually happened.

THANK YOU !