Outsourcing Variable costs: Direct material 0.06 $ 0.06 $ Direct labor 0.04 0.04 Variable overhead 0.04 0.04 Fixed costs: Supervisory salaries 0.04 0.01 Equipment depreciation 0.07 - Total cost per dessert 0.25 $ 0.15 $ Not all of the allocated fixed costs will be saved if Worldwide purchases from the outside bakery.
Make-or-Buy Decisions If Worldwide purchases the dessert for 21¢, it will only save 15¢ so Worldwide will have a loss of 6¢ per dessert purchased. Wow, that’s no deal!
Make-or-Buy Decisions Example The estimated costs of producing 6,000 units of a component are: Per Unit Total Direct Material $10 $60,000 Direct Labor 8 48,000 Applied Variable Factory Overhead 9 54,000 Applied Fixed Factory Overhead 12 72,000 $1.5 per direct labor dollar $39 $234,000
Make-or-Buy Decisions Example The same component can be purchased from market at a price of $29 per unit. If the component is purchased from market, 25% of the fixed factory overhead will be saved. Should the component be purchased from the market? Per Unit Total Make Buy Make Buy Purchase Price $29 $174,000 Direct Material $10 $60,000 Direct Labor 8 48,000 Variable Overhead 9 54,000 Relevant Fixed Overhead 3 18,000 Total Relevant Costs $30 $29 $180,000 $174,000 Difference in Favor of Buying $1 $6,000
Make-or-Buy Decisions Nantucket Nectars Company’s Cost of Making 12 -ounce Bottles Direct material $ 60,000 $.06 Direct labor 20,000 .02 Variable factory overhead 40,000 .04 Fixed factory overhead 80,000 .08 Total costs $200,000 $.20 Another manufacturer offers to sell Nantucket Nectars the bottles for $.18. Should Nantucket Nectars make or buy the bottles?
Make-or-Buy Decisions Perhaps Nantucket Nectars will eliminate $50,000 of fixed costs if the company buys the bottles instead of making them. For example, the company may be able to release a supervisor with a $50,000 salary. If the company buys the bottles, $50,000 of fixed overhead would be eliminated. Should Nantucket make or buy the bottles?
Make-or-Buy Decisions Purchase cost $180,000 $.18 Direct material $60,000 $.06 Direct labor 20,000 .02 Variable overhead 40,000 .04 Fixed OH avoided by not making 50,000 .05 0 0 Total relevant costs $170,000 $.17 $180,000 $.18 Difference in favor of making $ 10,000 $.01 Total Per Bottle Total Per Bottle Make Buy *Note that unavoidable fixed costs of $80,000 – $50,000 = $30,000 are irrelevant. Thus, the irrelevant costs per unit are $.08 – $.05 = $.03.
Make or Buy and the Use of Facilities • The value received from the best of alternative uses is an opportunity cost for the internal production of the parts or components • Assume Nantucket Nectars facilities would remain idle, if the company chose to buy the bottles. • The opportunity cost of the facilities is zero
Make or Buy and the Use of Facilities Suppose Nantucket can use the released facilities in other manufacturing activities to produce a contribution to profits of $55,000, or can rent them out for $25,000. What are the alternatives?
Make or Buy and the Use of Facilities Rent revenue $ — $ — $ 25 $ — Contribution from other products — — — 55 Variable cost of bottles (170) (180) (180) ( 180) Net relevant costs $(170) $(180) $(155) $(125) Make Buy and leave facilities idle Buy and rent out facilities Buy and use facilities for other products (amounts in $000)
Make or Buy and the Use of Facilities • Buying the bottles and using the vacated facilities for
- Fall '19
- Limited Resources, Nantucket Nectars, Misspecified Costs
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