Question

Question 5: Relevant information for decisions (20 marks in total)

The development of a new pesticide for the horticultural industry has been successful. David is now discussing with you, options to expand operations to include this new line of pesticide, Microcide. A key issue is whether to make one of the components of the pesticide, Factor X, or to buy it in. Demand for the next 12 months is expected to be 200,000 litres. Costs if FOL makes all the components are as follows:

Direct material		$ 1,200,000
Direct labour		$ 190,000
Factory overhead variable		$ 25,000
Factory overhead fixed		$   300,000
Total costs		$ 1,715,000

If FOL buys in the Factor X the unit costs of direct material will increase by 10%. Fixed costs will decrease by 65% representing the costs of the additional section of the production line which are avoided if the Factor X is bought in.

If FOL produces Factor X as part of the joint process of producing Microcide production, there will be a surplus of 30,000 litres of Factor X which can be sold at $4.50 per litre.

Required

1. Prepare a schedule that compares the make or buy alternatives. Show totals and amounts per unit. Calculate the difference between making and buying?

Answer 1

	Make		Buy
	Total	Per Unit	Total	Per Unit
Direct material cost	$       12,00,000	$       6.00	$    13,20,000	$         6.60
Direct labor cost	$         1,90,000	$       0.95	$       1,90,000	$         0.95
Factory overhead variable	$             25,000	$       0.13	$          25,000	$         0.13
Factory overhead fixed	$         3,00,000	$       1.50	$       1,05,000	$         0.53
Total cost	$       17,15,000	$       8.58	$    16,40,000	$         8.20
Less: Sale value of surplus = 30000*4.5 =	$         1,35,000	$       0.68	0	$              -
Net total cost	$       15,80,000	$       7.90	$    16,40,000	$         8.20
Decision:
As the net total cost is lower for the make alternative, FOL should make the component.