Question

Submit a paper which is 2-3 pages in length (no more than 3-pages), exclusive of the reference page. Paper should be double spaced in Times New Roman (or its equivalent) font which is no greater than 12 points in size. The paper should cite at least two sources in APA format.  One source can be your textbook.

Please describe the circumstances of the following case study and recommend a course of action. Explain your approach to the problem, perform relevant calculations and analysis, and formulate a recommendation. Ensure your work and recommendation are thoroughly supported.

Case Study:

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.

DescriptionCost per MonthDirect Materials   $75,000Direct Labor$100,000Total$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?

Superior papers will:

Perform all calculations correctly.

Articulate the approach to solving the problem, including which financial information is relevant and not relevant.

Correctly conclude on whether the company should make or buy the engines.

Answer 1

The question calls for making a decision as to whether a
component should be made internally of bought from
outside. What is required is a make or buy decision.
The approach to be adopted is a differential cost
analysis, in which, the total costs for each alternative
are put side by side and the differential costs are
calculated. It the total costs have come down, the
alternative that has the lower total costs would be
considered.
Differential costing technique can be adopted to
evaluate alternative actions that may be situations like,
change in sales mix, sales price, make or buy, dropping
a product etc.
The total costs for the two alternatives and their
difference are given in table below:
	Make	Buy	Difference [Buy-Make}
Cost of purchase [50000*60]		$ 30,00,000	$ 30,00,000
Direct materials	$ 75,000	$                    -	$    -75,000
Direct labor	$      1,00,000	$                    -	$   -1,00,000
Variable overheads [50000*$7.5]	$      3,75,000	$                    -	$   -3,75,000
Fixed overheads [100000*150%/100000*150*75%]	$      1,50,000	$ 1,12,500	$    -37,500
Total cost	$      7,00,000	$ 31,12,500	$ 24,12,500
As the total cost for 'make' is lower, the firm should
make the component.