Question

X Company is considering buying a part next year that they currently make. This year's per-unit production costs for 3,000 units were:

Materials	$2.86
Direct labor [all variable]	3.68
Variable overhead	2.70
Fixed overhead	3.70
Total production costs	$12.94

A company has offered to supply this part for $11.73 per unit. If X Company buys the part, $6,438 of the fixed overhead can be avoided. Also if X Company buys the part, it can use the freed-up resources to increase production of another product, resulting in additional contribution margin of $2,300. Production next year is also expected to be 3,000 units.

At what production level would X Company be indifferent between making and buying the part?

Answer 1

• X Company would be at indifferent point where the net cost of making the part and net cost of buying the cost is equal.
• Let us first say that the indifference number of units be ‘x’
• Now, if ‘x’ is made, the total cost would be:

2.86x(material cost) + 3.68x(labor cost) + 2.7x(variable overhead) + 11100(fixed overhead)
=9.24x + 11100 [Equation 1]

* If the parts are purchased, variable cost of production will not be incurred, rather $11.73 per part will be purchase cost. Fixed cost will be reduced by $6438 and there will be net gain of $2300 (as given in question)

Hence, net cost will be: 11.73x + (11100-6438=Fixed cost) – 2300(Additional gain)
=11.73x + 4662 – 2300 = 11.73x + 2362 [Equation 2]

• At Indifference point, both the equations will be equal to each other,
  Hence, 9.24x + 11100 = 11.73x + 2362
  11100 – 2362 = 11.73x – 9.24x
  8738 = 2.49x
  x = 8738/2.49
  x = 3509.24 units.
• Hence, at 3509 or 3510 units level, the X company will be at indifference point and its costs will be same if it purchases the part or produces the part.