Make or Buy
Smith Corporation currently manufactures a subassembly for its main product. The costs per unit are as follows:
Direct materials $ 1
Direct labor 10
Variable overhead 5
Fixed overhead 8
Total $24
Funkhouser Company has contacted Smith with an offer to sell it 5,000 of the subassemblies for $20 each. If Funkhouser makes the subassemblies, $5 of the fixed overhead per unit will be allocated to other products.
Required:
a. Should Smith make or buy the subassemblies? Explain your answer. What would be the impact on Net Income? (Make table)
b. What if Smith could rent the space currently used to manufacture the subassemblies for $15,000. What should they do now? What is the impact on Net Income? (Make table)
c. What other factors should Smith consider in making this decision?
Solution a) Differential Analysis of the two options
Make $ |
Buy $ |
Difference in Income $ = Make - Buy |
|
Purchase Price |
0.00 |
20.00 |
-20.00 |
Direct Material |
1.00 |
0.00 |
1.00 |
Direct Labour |
10.00 |
0.00 |
10.00 |
Variable Overheads |
5.00 |
0.00 |
5.00 |
Total Variable Cost per Unit |
16.00 |
20.00 |
-4.00 |
Total Variable Cost = Total Variable Cost per Unit x 5000 units |
80,000.00 |
1,00,000.00 |
-20,000.00 |
Fixed Cost per unit |
8.00 |
3.00 |
5.00 |
Total Fixed Cost = Total Fixed Cost per Unit x 5000 units |
40,000.00 |
15,000.00 |
25,000.00 |
Total Cost = Total Variable Cost + Total Fixed Cost |
1,20,000.00 |
1,15,000.00 |
5,000.00 |
Cost per Unit = Total Cost / 5000 Units |
24.00 |
23.00 |
1.00 |
Smith Corporation should buy the subassemblies from Funkhouser Company as that would increase its Net Income by $5,000
Solution b)
Make $ |
Buy $ |
Difference in Income $ = Make - Buy |
|
Purchase Price |
0.00 |
20.00 |
-20.00 |
Direct Material |
1.00 |
0.00 |
1.00 |
Direct Labour |
10.00 |
0.00 |
10.00 |
Variable Overheads |
5.00 |
0.00 |
5.00 |
Total Variable Cost per Unit |
16.00 |
20.00 |
-4.00 |
Total Variable Cost = Total Variable Cost per Unit x 5000 units |
80,000.00 |
1,00,000.00 |
-20,000.00 |
Fixed Cost per unit |
8.00 |
3.00 |
5.00 |
Total Fixed Cost = Total Fixed Cost per Unit x 5000 units |
40,000.00 |
15,000.00 |
25,000.00 |
Total Cost = Total Variable Cost + Total Fixed Cost |
1,20,000.00 |
1,15,000.00 |
5,000.00 |
Cost per Unit = Total Cost / 5000 Units |
24.00 |
23.00 |
1.00 |
Income from Renting the Free Space |
0.00 |
15,000.00 |
15,000.00 |
Net Cost = Total Cost - Income from Renting the Free Space |
1,20,000.00 |
1,00,000.00 |
20,000.00 |
If Smith Corporation receives $15,000 as an income from renting the space then still it will be recommended to buy the subassemblies from Funkhouser Company as that would increase its Net Income by $20,000.
Solution c) Factors Smith Corporation should consider in making this decision:
The Variables considered at the strategic level include analysis
of the future, as well as the current environment. Issues like
government regulation, competing firms, and market trends all have
a strategic impact on the make-or-buy decision.
Elements of the "make" analysis include:
Cost considerations for the "buy" analysis include:
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