Question

Foster Industries manufactures 20 000 components per year. The manufacturing cost of the component were determined as follows:

R

Direct materials
150 000

Direct labour
240 000

Inspecting products
60 000

Providing power
30 000

Providing supervision
40 000

Setting up the equipment
60 000

Moving materials
20 000

Total
600 000

If the component is not produced by Foster, inspection of products and provision of power costs will only be 10% of the current production costs; moving materials costs and setting up equipment costs will only be 50% of the production costs; and supervision costs will amount to only 40% of the production amount. An outside supplier has offered to sell the component for R25.50 per unit.

Required:

4.1 Should Foster Company make or buy the component? Why? (9)

Answer 1

Relevant Costs

	Make	Buy	Difference
Direct materials	$      150,000		$      150,000
Direct labour	$      240,000		$      240,000
Inspecting products	$         54,000		$         54,000
Providing power	$         27,000		$         27,000
Providing supervision	$         24,000		$         24,000
Setting up the equipment	$         30,000		$         30,000
Moving materials	$         10,000		$         10,000
Purchase Price		$      510,000	$     (510,000)
Total	$      535,000	$      510,000	$        25,000

Foster should buy the component since it increases operating income by $25,000