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p is considering whether to continue making a product or to buy it from an outside supplier. It uses 12000 of the components each year
The internal manufacturing cost comprises:
Direct materials 3
Direct labour 4
Variable overhead 1
Specific fixed cost 2.5
Other fixed costs 2
If 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 per unit but requires 8 of labour per unit
What is the maximum price per component at which buying is preferable to internal manufactureI have asked you before to please not simply type out a full question and expect to be provided with a full answer. You will obviously have an answer in the same book in which you found the question, so please ask about whatever it is in the answer that you are not clear about and then I will explain.
It is asking for the most they would be prepared to pay to buy it from outside rather than make it themselves.
If the buy from outside they will save some of the costs of making it themselves.
If the cost of buying outside is less than the savings they make then it is better to buy outside. If the cost of buying outside is more than the savings they make then it is not better to buy outside.
So the most they would be prepared to pay is equal to the savings they would make by not producing themselves.
I calculated the answer to be 10 because it is the contribution lost if the manufacturing of the product is carried on. But this is incorrect. I don’t understand why
If the bought the product from outside, then they would save the variable and specific fixed costs of making it themselves. In addition they would earn a contribution from using the labour on another product, but the other product uses twice as much about per unit as the current product (because the labour cost is twice as high) and so every unit not made of the current product would earn them $5 contribution from the other product.
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