Question

BAF Ltd produces and sells to wholesalers various kinds of office stationery. The company is planning to introduce one new product for this coming summer. The new product is a newly designed stapler. The product will be sold to wholesalers in batches of 20 for $9 each. The capacity is available so no additional fixed costs in this will be incurred to produce the new product. Instead, a $190,000 fixed fee will be assigned to allocate a fair share of the company’s fixed costs to the new product. The remaining overheads are variable.

The new product is made of a number of parts and components which can be made internally. Using estimated sales and production of 100,000 batches of the new product as the standard volume, the following costs per batch of 20 staplers are developed:

Direct materials	$7
Direct labor	$4
Total overheads	$3

The company is negotiating with a supplier about the possibility of purchasing one of the parts, Part X, for the new product. The supplier quotes a purchase price of $2 per 20 units of Part X. If the company accepts and purchases this part from the supplier, it is estimated the direct labor cost and variable overheads would be reduced by 10 percent and direct materials costs would be reduced by 20 percent.

Decisions are to be made based on financial effects only.

Requirement:

Q30-A.     Should BAF Ltd make or buy Part X? Support your answer with calculations.

Q30-B.      What would be the maximum purchase price per unit of Part X acceptable to BAF Ltd?

Q30-C.      BAF Ltd is changing the estimates to have a sales volume at 130,000 units of the new product. Additional machine is needed to produce more units of Part X and the annual rental is $16,000. The additional machine can produce up to 200,000 units of Part X. Should BAF Ltd make or buy Part X? Support your answer with calculations.

Q30-D.      BAF Ltd is changing the estimates to have a sales volume at 130,000 units of new product. Additional machine is needed to produce more units of Part X and the annual rental is $16,000. The additional machine can produce up to 200,000 units of Part X. BAF Ltd has an additional option to make some and buy the rest of Part X. Hence, the company now has two options available so that the total cost in relation to the new product must be minimized: (a) make as many units of Part X as possible and buy the rest; (b) buy all units of Part X.

Which option, (a) or (b), should BAF Ltd select? Support your answer with calculations.

Answer 1

Make-or-buy decisions involve the assessment of whether an organization should continue manufacturing a product or service 'in-house', or if it should just buy those from an outside supplier.

Q 30-A

Calculation of Variable O/h

Total O/h Cost Per Batch = $3

Less Fixed O/h $190,000 ie = 1.9

Variable O/h = $1.1

Contribution Per Batch

If the company Makes Product X

Sales Price = $9

Les: Varible Costs

D.Material = $7

D. Labour = $4

O/Heads = $1.1

Contribution Per Batch = $(3.1)

If the company Buys Product X

Sales Price = $9

Les: Varible Costs

D.Material = $5.6

D. Labour = $3.6

O/Heads = $.99

Contribution Per Batch = $(1.19)

As the contribution per batch is increasing company should buy the Product X.

Q 30-B

Maximum Purchase Price of Product X acceptable to BAF Ltd.

BAF Ltd should quote that price where its Variable costs can be recovered.

Hence, Maximum Purchase Price

= $ 2- 1.19

= $ 0.81

Q 30-C

Total Appliacble/avoidable Expenses for making 130,000 units stapler

D.Material = $7 x 130,000 = $ 910,000

D. Labour = $4 x 130,000 = $ 520,000

Variable O/h = $ 1.1 x 130,000 = $ 143,000

Machine Rent = Not Relevant

Total Cost = $ 12.1 x 130,000 = $ 1,573,000

Total Expenses for buying 130,000 units stapler

$10.19 x 130,000 = $ 1,324,700

Saving in Cost = $ 1573000 - 1324700

= $248,300

BAF Ltd should buy the Product X..

Q 30-D

Break Even Point

130000 + 10.19 = 12.1

= 68000 batches

it would be beneficial for the company to buy 130,000 batchess if demand is less than or equal to 130,000 batches.

if demand is increases, it would be benefiacal for the company to produce 68000 batches and buy the rest.