Question

6-33 Make or Buy at Nantucket Nectars

1. Assume that Nantucket Nectars reports the following costs to make 17.5 oz bottles for its juice cocktails:

Nantucket Nectars Company

Cost of making 17.5-ounce bottles

	Total cost for 1,000,000 Bottles	Cost per Bottle
Direct materials	$ 80,000	$ .80
Direct Labor	30,000	.30
Variable Factory Overhead	60,000	.60
Fixed factory overhead	85,000	.85
Total costs	$255,000	$2.55

Another manufacturer offers to sell Nantucket Nectars the bottles for $.25. The capacity now used to make bottles will become idle if the company purchases the bottles. Further, one supervisor with a salary of $60,000, a fixed cost, would be eliminated if the bottles were purchased. Prepare a schedule that compares the costs to make and buy the 17.5 oz bottles. Should Nantucket make or buy the bottles?

2. Refer to the preceding exercise. Suppose Nantucket Nectars can use the released facilities in another manufacturing activity that makes a contribution to profits of $75,000 or can rent them out for $55,000. Prepare a schedule that compares the four alternative courses of action. Which would yield the lowest net cost?

Answer 1

while deciding for whether to make or buy the product , relevant costs are to be considered. The unavoidable fixed costs will remain same in both the alternative.

	Make	Buy	Increase(decrease) in income
Direct materials	$ 80,000	-	$80,000
Direct Labor	30,000	-	$30,000
Variable Factory Overhead	60,000	-	$60,000
Fixed factory overhead	85,000	$25,000 [60,000 supervisior cost is avoidable]	$60,000
Purchase price	-	$250,000[$0.25*1,000,000]	($250,000)
Total costs	$255,000	$275,000 [$25,000+250,000]	($20,000)

Nantuck should make the bottles as it costs $25,000 lesser than if bought from outside.

2)

	Make [Alt I	Buy [Alt II]	Make another product	Rent
Direct materials	$ 80,000	-	-	-
Direct Labor	30,000	-	-	-
Variable Factory Overhead	60,000	-	-	-
Fixed factory overhead	85,000	$25,000 [60,000 supervisior cost is avoidable]	$25,000 [60,000 supervisior cost is avoidable]	$25,000 [60,000 supervisior cost is avoidable]
Purchase price	-	$250,000[$0.25*1,000,000]	$250,000[$0.25*1,000,000]	$250,000[$0.25*1,000,000]
Contribution margin	-	-	($75,000)	($55,000) it will reduce cost
Total Net costs	$255,000	$275,000 [$25,000+250,000]	$200,000[$25,000+250,000-75,000]	$220,000[$25,000+250,000-55,000]

Accepting an offer to by from outside and making another product will result into lowest net cost.