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The Pastel Company must reach a make/buy decision with respect to a high-volume, easily made metal tool, RG1. Sean

Gray, the cost analyst, estimates the following costs and production information for the 50,000 units of RG1 that are expected to be put into production.

Total direct materials costs

$660,000

Direct manufacturing labour costs (all variable)

220,000

Manufacturing overhead costs (all fixed)

440,000

Good units of RG1 manufactured and sold

40,000 units

Units of RG1 scrapped for zero revenue

10,000 units

York Corporation has offered to supply as many units of RG1 as Pastel needs for $23.10 per unit. If Pastel buys RG1 from York instead of manufacturing it in-house, Pastel would be able to save $263,450 of the $440,000 fixed manufacturing overhead costs.

Gray shows his analysis to Kim Berry, the controller. Berry does not like what he sees. He asks Gray to review all his assumptions and calculations, commenting, "The yield assumptions you made are very low. I think this plant can achieve much better quality than we have in the past. Better quality will reduce our costs and make them competitive with the outside purchase price." Gray knows that Berry is very concerned about purchasing RG1 from an outside supplier because it will mean that some of his close friends who on the RG1 line will be laid off. Berry had played a key role in convincing management to produce RG1 in-house.

Gray rechecks his calculations. He believes it is unlikely that the plant can achieve the quality levels it would take for the make alternative to be superior to the buy alternative.

Required:

1. Based on the information Gray obtains, should Pastel make or buy RG1?

2. For what levels of scrap would the make alternative be preferred to purchase from outside?


I just need help with question 2. Do I need to calculate the point of indifference?

Top Answer

1.Make Vs Buy option: A.Relevant cost for production of RG 1 : Total direct material = $ 660000 Direct manufacturing labour... View the full answer

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