Question

Structuring a Make-or-Buy Problem

Fresh Foods, a large restaurant chain, needs to determine if it would be cheaper to produce 5,000 units of its main food ingredient for use in its restaurants or to purchase them from an outside supplier for $12 each. Cost information on internal production includes the following:

	Total Cost		Unit Cost
Direct materials	$25,000		$5.00
Direct labor	15,000		3.00
Variable manufacturing overhead	7,500		1.50
Variable marketing overhead	8,000		1.60
Fixed plant overhead	30,000		6.00
Total	$85,500		$17.10

Fixed overhead will continue whether the ingredient is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price. If required, round your answers to the nearest whole number.

Required:

1. What are the alternatives for Fresh Foods?

2. List the relevant cost(s) of internal production and of external purchase.

3. Which alternative is more cost effective and by how much? (Use total cost when giving your answer.)

$

4. Now assume that 20% of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost effective and by how much? (Use total cost when giving your answer.)

$

Answer 1

1 SOLUTION 2 1 There are two alternatives first to produce second to purchase from external sources. 3 2 4 cost of internal production for 5000 units Total Unit Cost 5 Cost Direct materials $25,000 $5.00 6 Direct labor 15,000 3.00 7 7,500 1.50 8 Variable manufacturing overhead Variable marketing overhead 8,000 1.60 9 Fixed plant overhead 30,000 6.00 10 Total $85,500 $17.10 11 Unit Cost 12 13 14 15 16 Cost of external purchase for 5000 units Purchase price Fixed plant overhead TOTAL Total Cost 60000 30000 90000 12 6 18

1 2 3 4 3 Internal production is more cost efficient because it is cheaper than purchase Difference in cost = $ 90.000-$85,500=$ 4,500 5 6 7

2 Total 3 12 4 Purchase price Fixed overheads Total cost per unit 60000 24000 84,000 4 4.8 16.8 5 6 7 If fixed overheds can be avoided by 20% than total cost by purchase shall be $84.000 which is less than cost of internal production. Thus its better to make outside purchase in this case. 8 9 NOTE - PLEASE UPVOTE IT SHALL BE A GREAT FAVOR THANKS 10 11 12 13 14 15 16 17 18 19