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05bottle drhusseinkhasharmeh drhusseinkhasharmeh

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Unformatted text preview: will become idle (this means now used to make Bottles will become idle (this means that opportunity cost is zero). that opportunity cost is zero). Should Nantucket make or buy the bottles? Should Nantucket make or buy the bottles? Dr. Hussein Khasharmeh Dr. Hussein Khasharmeh Relevant Cost Comparison Make (1,000,000) Buy (1,000,000) Total Total Purchase cost Direct material $ 60,000 Direct labor 20,000 Variable overhead 40,000 Fixed OH avoided by not making 50,000 Total relevant costs $170,000 Difference in favor of making $ 10,000 = * 50,000 / 1,000,000 $0.05 / bottle Dr. Hussein Khasharmeh Dr. Hussein Khasharmeh Per Bottle $.06 .02 .04 $180,000 Per Bottle $.18 .05* 0 0 $.17 $180,000 $.18 $.01 Make or Buy and the Use of Facilities Suppose Nantucket can use the released Suppose Nantucket can use the released facilities in other manufacturing activities facilities in other manufacturing activities to produce a contribution to profits of to produce a contribution to profits of $55,000, or can rent them out for $25,000. $55,000, or can rent them out for $25,000. What are the alternatives? What are the alternatives? We now have four alternatives to consider We now have four alternatives to consider as follows: as follows: Dr. Hussein Khasharmeh Dr. Hussein Khasharmeh Make or Buy and the Use of Facilities Make (000) Buy and leave facilities idle Buy and rent out facilities Buy and use facilities for other products ent revenue $ — $ — $ 25 $ — Rent revenue $ — $ — $ 25 $ — ontribution from Contribution from other products — — — 55 other products — — — 55 ariable cost of bottles (170) (180) (180) (180) Variable cost of bottles (170) (180) (180) (180) et relevant costs $(170) $(180) $(125) Net relevant costs $(170) $(180) $(155) $(155) $(125) Dr. Hussein Khasharmeh Dr. Hussein Khasharmeh The analysis indicates that buying the bottles and The using facilities for other products would yield the lowest net cost and save $45,000 (170,000-125,000). The answer is to choose buying and using facilities for other products. for We can use the opportunity cost in the analysis and We still reach the same answer as follows: still Cost to make bottles (in $,000): Outlay cost $170,000 Opportunity cost 55,000 Opportunity 55,000 Total cost $225,000 which is higher (by Total $45,000) than the cost of purchasing them ($180,000). ($180,000). In summary, the make or buy decision should focus on In relevant costs. relevant Dr. Hussein Khasharmeh Dr. Hussein Khasharmeh Deletion or addition of products, services, or departments: Avoidable and Unavoidable Costs: Avoidable costs are costs that will not continue if an ongoing operation is changed or deleted and are relevant. Unavoidable costs are costs that continue even if the company discontinues (halted) an operation (and are irrelevant). They include many common costs (shared by users) like heating. Dr. Hussein Khasharmeh Dr. Hussein Khasharmeh Department Store Example Consider a discount department store that has three major departments: 1. Groceries 2. General merchandise 3. Drugs Dr. Hussein Khasharmeh Dr. Hussein Khasharmeh Department Store Example Depa...
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