Question

Describe how you would go about analyzing a make-or-buy decision when:

1. Your in-house production capability is not being used to full capacity.

2. You do not have the in-house production capability but could acquire it.

3. You have the in-house capability, but demand for its use exceeds full capacity.

Answer 1

1. Your in-house production capability is not being used to full capacity :

Such a decision making alternative requires the firm to compare the price being paid to outside supplier with all costs that are to be incurred to manufaturing the product.

Buy Decision include costs :

1. purchase price

2. Transportation cost

3.reciving and inspection cost

4. Any Other cost related to purchase

Make decision cost:

1. Incremenal carrying cost

2. Direct cost (material, laobr)

3. Incremental capital cost

4. Incremant factory overhead  cost

5. Any other cost related to manufacturing.

b)You do not have the in-house production capability but could acquire it.

In Such case  incremental costs will include variable costs plus fixed overhead allocable to the part's manufacture.

c.You have the in-house capability, but demand for its use exceeds full capacity.

If firm can increase the capicity by investing the fixed cost. In such case, Firm should do break even analysis before investing in fixed cost. Break-even analysis can be an effective way to analyze cost implications within a decision. it would be more cost effective for a firm to buy if demand is less than break even point, and make the part if demand exceeds break even point.

For ex. Firm purchase a machinery for 400,000. produce the part for $10 each. From the supplier he purchase from $20.

Break even analysis:.

$400,000 + $10Q = $20Q
$400,000 = $20Q − $10Q
$400,000 = $10Q
40,000 = Q

If demand exceed 40,000 than only firm has to invest in machinery otherwise not.