Structuring a Make-or-Buy Problem Fresh Foods, a large restaurant chain, needs 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 outside supplier for $12 each. Cost information on internal production includes the following:

Question

Total Cost Unit Cost
Direct materials $25,000 $ 5.00
Direct labor 15,000 3.00
Variable manufacturing overhead 7,500 1.50
Variable marketing overhead 10,000 2.00
Fixed plant overhead 30,000 6.00
Total $87,500 $17.50

Fixed overhead will continue whether the ingredient is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price.

1. What are the alternatives for Fresh Foods?
2. List the relevant cost(s) of internal production and of external purchase.
3. Which alternative is more cost-effective?
4. Now assume that 20% of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost-effective?
By how much?

Answer 1

Ans:
1. make the ingredient in house or buy it externally
2. Direct material, direct labor, variable purchase, purchase price (Relevant costs of making the component in-house consist of direct materials, direct labor, and variable overhead. Relevant costs include the purchasing the component externally inclusive of the purchase price)
3. make the ingredient in-house
BUYING: Cost+ FC=TC
(12 *5000 units)+ 30,000= 90,000
MAKE: DM+DL+Variable Manu Overhead+Variable Mark Overhead+Fixed plant overhead=
25,000+15,000+7,500+10,000+30,000=87,500
= 90,000-87,500= 2,500
4. Buy- 3,500
BUY: (12 5000 units)+(30,00080%)= 84,000
MAKE: DM+DL+Variable Manu Overhead+Variable Mark Overhead+Fixed plant overhead=
25,000+5,000+7,500+10,000+30,000= 87,500
87,500-84,000=3,500