10.4 Decision Making - Make or Buy Flashcards
In a make-versus-buy decision, the relevant costs include variable manufacturing costs as well as
A. Factory management costs.
B. General office costs.
C. Avoidable fixed costs.
D. Depreciation costs.
C. Avoidable fixed costs.
The relevant costs in a make-versus-buy decision are those that differ between the two decision choices. These costs include any variable costs plus any avoidable costs. Avoidable fixed costs will not be incurred if the buy decision is selected.
Listed below are a company’s monthly unit costs to manufacture and market a particular product.
Manufacturing costs:
Direct materials $2.00
Direct labor 2.40
Variable indirect 1.60
Fixed indirect 1.00
Marketing costs:
Variable 2.50
Fixed 1.50
The company must decide to continue making the product or buy it from an outside supplier. The supplier has offered to make the product at the same level of quality that the company can make it. Fixed marketing costs would be unaffected, but variable marketing costs would be reduced by 30% if the company were to accept the proposal. What is the maximum amount per unit that the company can pay the supplier without decreasing operating income?
A. $8.50
B. $6.75
C. $7.75
D. $5.25
B. $6.75
The key to this question is, what costs will the company avoid if it buys from the outside supplier? It will no longer incur the $2.00 of direct materials, nor the $2.40 of direct labor, nor the $1.60 of variable overhead, nor $0.75 ($2.50 × 30%) of the variable marketing costs (regardless of whether the company makes or buys, it will still incur 70% of the variable marketing costs). The firm will therefore avoid costs of $6.75 ($2.00 + $2.40 + $1.60 + $0.75). Thus, it will at least break even by paying no more than $6.75.
A manufacturer produces hacksaw blades. Recently, the manufacturer has decided to enhance its product line and offer band blades. Two alternatives are being analyzed: purchase band blades overseas or produce them in-house. If the band blades are made in-house, the manufacturer will not be able to produce hacksaw blades, forgoing a $30,000 profit contribution.
Revenue from sale of band blades $180,000
Outside purchase 170,000
Direct material and labor 100,000
Variable manufacturing overhead 50,000
Avoidable fixed manufacturing overhead 10,000
Calculate the incremental cost of making band blades.
A. $160,000.
B. $150,000.
C. $180,000.
D. $190,000.
D. $190,000.
The incremental cost of making the band blades is $190,000 ($100,000 direct material and labor + $50,000 variable manufacturing overhead _ $10,000 avoidable fixed manufacturing overhead + $30,000 forgone profit contribution).
Regis Company manufactures plugs used in its manufacturing cycle at a cost of $36 per unit that includes $8 of fixed overhead. Regis needs 30,000 of these plugs annually, and Orlan Company has offered to sell these units to Regis at $33 per unit. If Regis decides to purchase the plugs, $60,000 of the annual fixed overhead applied will be eliminated, and the company may be able to rent the facility previously used for manufacturing the plugs.
If the plugs are purchased and the facility rented, Regis Company wishes to realize $100,000 in savings annually. To achieve this goal, the minimum annual rent on the facility must be
A. $40,000
B. $10,000
C. $190,000
D. $70,000
C. $190,000
If Regis purchases the plugs, Regis will still incur fixed costs per unit of $6 [$8 – ($60,000 ÷ 30,000 units)]; however, because these costs are committed (sunk costs), they are not relevant to this decision. Thus, the relevant cost per unit will be $30 ($36 cost – $6 fixed cost per unit). Without regard to rental of idle production capacity, the company will lose $3 per unit ($33 purchase price – $30 relevant cost) by purchasing the plugs. The total annual loss will be $90,000 (30,000 units × $3). Consequently, to achieve the targeted savings, the minimum annual rent must be $190,000 ($90,000 loss from purchasing + $100,000 targeted savings).
Refrigerator Company manufactures ice-makers for installation in refrigerators. The costs per unit, for 20,000 units of ice-makers, are as follows.
Direct materials $ 7
Direct labor 12
Variable overhead 5
Fixed overhead 10
Total costs $34
Cool Compartments, Inc., has offered to sell 20,000 ice-makers to Refrigerator Company for $28 per unit. If Refrigerator accepts Cool Compartments’ offer, two alternatives are available for the ice-maker manufacturing plant: the plant can be idled or it can be retooled to produce water filtration units.
If Refrigerator retools its existing plant, revenues from the sale of water filtration units are estimated at $80,000, with variable costs amounting to 60% of sales. In addition, $6 per unit of the fixed overhead associated with the manufacture of ice-makers could be eliminated. For Refrigerator Company to determine the most appropriate action to take in this situation, the total relevant costs of make vs. buy, respectively, are
A. $680,000 vs. $440,000.
B. $648,000 vs. $528,000.
C. $$600,000 vs. $560,000.
D. $600,000 vs. $528,000.
D. $600,000 vs. $528,000.
Relevant costs are those that vary depending on the option chosen. Thus, $4 per unit of fixed overhead (20,000 units × $4 = $80,000) will be incurred regardless of the option chosen. This amount is irrelevant to the decision. The costs eliminated by buying ice-makers are the relevant costs of making the ice-makers. They equal $24 per unit ($7 + $12 + $5) of variable costs (20,000 units × $24 = $480,000) and $6 per unit of fixed costs (20,000 units × $6 = $120,000), a total of $600,000. If the ice-makers are bought, and the plant is retooled, the contribution margin from the sale of water filters is $32,000 ($80,000 × 40%). Thus, the $560,000 price of ice-makers (20,000 units × $28) is reduced by $32,000, giving relevant costs of buying of $528,000.
A multiproduct company currently manufactures 30,000 units of Part 730 each month for use in production. The facilities now being used to produce Part 730 have fixed monthly overhead costs of $150,000 and a theoretical capacity to produce 60,000 units per month. If the company were to buy Part 730 from an outside supplier, the facilities would be idle and 40% of fixed costs would continue to be incurred. There are no alternative uses for the facilities. The variable production costs of Part 730 are $11 per unit. Fixed overhead is allocated based on planned production levels. If the company continues to use 30,000 units of Part 730 each month, it would realize a net benefit by purchasing Part 730 from an outside supplier only if the supplier’s unit price is less than
A. $14.00
B. $13.00
C. $12.50
D. $12.00
A. $14.00
The relevant cost to the company has two components. One is its own variable production cost for Part 730 ($11). The other is that portion of fixed costs that are incurred if production is done in-house ($150,000 x 60% = $90,000); on a per unit basis, this translates into $3 ($90,000 / 30,000 = $3). The total threshold for the outside supplier’s price is therefore $14 ($11 + $3).
