Question

A vacuum manufacturer has prepared the following cost data for manufacturing one of its engine components based on the annual production of 50,000 units.

Description	Cost per Month
Direct Materials	$75,000
Direct Labor	$100,000
Total	$175,000

In addition, variable factory overhead is applied at $7.50 per unit. Fixed factory overhead is applied at 150% of direct labor cost per unit. The vacuums sell for $150 each. A third party has offered to make the engines for $60 per unit. 75% of fixed factory overhead, which represents executive salaries, rent, depreciation, and taxes, continue regardless of the decision. Should the company make or buy the engines?

Answer 1

The company should make engines since the net income has decreased by $487,500. In other words, the cost of buying is more than making the engines.

Workings:

	Make	Buy	Net Income Increase / (Decrease)
Direct Materials [75000*12]	900,000		900,000
Direct Labor [100,000*12]	1,200,000		1,200,000
Variable Overheads [50,000*7.5]	375,000		375,000
Fixed overheads [50,000*2*150%]	150000	112500	37500
Purchase price [50,000*60]		3000000	-3,000,000
Total	2,625,000	3,112,500	-487,500