Question

Please specifically explain the calculation and information needed in a Special order situation or Make or Buy situation – your choice.Please also include a step-by-step example of the situation you chose.

Answer 1

Make or Buy decision is taken by the management whether to make a product internally or buy it from the market. It is also called the outsourcing decision .When taking a such decision two factors to be considered are;

1. Whether surplus capacity is available
2. The Variable Cost or Marginal Cost

The following qualitative factors are to be taken into consideration;

1. Control over quality of the component
2. Reliability of Suppliers
3. Impact of the decision on suppliers and customers

The quantitative factors are actually the incremental cost which is to be taken into consideration while taking make or buy decision

1. Incremental production cost per unit
2. Purchase cost per unit
3. Available production capacity for the product

A large restaurant chain, needed to determine if it would be cheaper to produce 5,000 units of its main food ingredient for use in its restaurants or to purchase them from an out- side supplier for $12 each. Cost information on internal production includes the following:

Total Cost               Unit Cost
Direct materials	$25,000		$ 5.00
Direct labor	15,000		3
Variable manufacturing overhead	7,500		1.5
Variable marketing overhead	10,000		2
Fixed plant overhead	30,000		6
Total	$87,500		$17.50

	Per Unit
Particulars	Make	Buy	Net advantage
Direct Material	5	0	5
Direct labor	3	0	3
Variable manufacturing Overhead	1.5	0	1.5
Variable marketing overhead	2	0	2.0
Fixed Manufacturing Overhead	6	6	-
Purchase Cost	0	12	(12)
Total Costs	16	18	(0.5)
As the net advantage is negative therefore, the offer should not be accepted.
And the ingredient must be produced internally. Total cost for producing the ingredient
is cheaper by ( 5000 *.5) =2500