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p is considering whether to continue making a component or to buy it from an outside supplier. it uses 12000 of the components each year
the internal manufacturing cost comprises:
direct material $3
direct labour $4
variable overhead $1
specific fixed cost $2.5
other fixed costs $2if the direct labour were not used to manufacture the component, it would be used to increase the production of another item for which there is unlimited demand. this other item has a contribution of $10 p.u but it requires $8 of labour per unit.
what is maximum price per component, at which buying is preferable to internal manufacture?
could you explain the calculation of contribution forgone with the context of this question, pleaseIf they do not manufacture the component themselves then instead they will produce the other item and make a contribution of $10 per unit.
However this other item take twice as many hours to produce as it does to produce the component (because the labour cost is twice as high at $8 instead of $4).
Therefore for every hour that they use to make the component themselves, they would be losing contribution from the other product that they could be making of $10/2 = $5.
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