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A company wants to decide whether to make its materials in-house or to sub-contract production to an external supplier. In the past it has made four materials in-house, but demand in the next year will exceed in-house production capacity of 8,000 units. All four materials are made on the same machines and require the same machine time per unit: machine time is the limiting production factor.
The following information is available.
Material
W
X
Y
Z
Units required
4,000
2,000
3,000
4,000
Variable cost of in-house manufacture
$8 per unit
$12 per unit
$9 per unit
$10 per unit
Directly attributable fixed cost expenditure
$5,000
$8,000
$6,000
$7,000
Cost of external purchase
$9 per unit
$18 per unit
$12 per unit
$12 per unit
Directly attributable fixed costs are fixed cash expenditures that would be saved if production of the material in-house is stopped entirely.
If a decision is made soleyly on the basis of short-term cost considerations, what materials should the company purchase externally?
the answer is 4000 units of W AND Z
But I got the answer as 4000 W AND 1000 Z,
Kindly Help me understand where i went wrong ,
thanksApologies I will try to explain
For W: External purchase is $9/unit, in-house is $8/unit. The extra cost per unit for buying externally is $1. For 4,000 units, the total extra cost would be $4,000. However, buying externally would save $5,000 in directly attributable fixed costs, leading to a net saving of $1,000.
For X: External purchase is $18/unit, in-house is $12/unit. The extra cost per unit for buying externally is $6. For 2,000 units, the total extra cost would be $12,000. Buying externally would save $8,000 in directly attributable fixed costs, leading to a net extra cost of $4,000.
For Y: External purchase is $12/unit, in-house is $9/unit. The extra cost per unit for buying externally is $3. For 3,000 units, the total extra cost would be $9,000. Buying externally would save $6,000 in directly attributable fixed costs, leading to a net extra cost of $3,000.
For Z: External purchase is $12/unit, in-house is $10/unit. The extra cost per unit for buying externally is $2. For 4,000 units, the total extra cost would be $8,000. Buying externally would save $7,000 in directly attributable fixed costs, leading to a net extra cost of $1,000.
Given the production capacity limit, the company should prioritize purchasing externally the materials that result in the lowest net extra cost or net savings. Material W offers a net saving of $1,000, and material Z has the lowest net extra cost of $1,000.
Therefore, the company should purchase material W externally to save $1,000 and then choose between materials X, Y, and Z to purchase externally based on the lowest net extra cost. Since Z has the lowest net extra cost of $1,000, the company should purchase material Z externally as well.
In conclusion, based on short-term cost considerations, the company should purchase 4,000 units of material W and 4,000 units of material Z externally.
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but we can make 8000 inhouse , 3000 of z inhouse and buy 1000 externally ? why would we buy 4000 z
The question asked
If a decision is made solely on the basis of short-term cost considerations, what materials should the company purchase externally?
- Topics: 53
- Replies: 46
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I still dont get it , sorry
Rather than looking at internally making them you are looking at which you should buy in to purchase externally based on the lowest net extra cost.
- Topics: 53
- Replies: 46
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thanks!
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