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Dear Tutor,
I would like to ask why we have to buy 4,000 units of Z instead of 1,000 units.
The question mention that fixed cost saving if production of the material in house is stopped entirely. Is that the reason?
The in answer we have the explain: “if in-house production of Z is reduced to 3,000 units, the additional cost of external purchasing would be only $6,000, so that $1,000 would e saved by purchasing all of Z externally”. I do not understand this. So could you please help me through this?Thank you so much.
If they purchased 1,000 externally then they would have extra costs of 1,000 x (12 – 10) = $2,000 and would not save any of the fixed costs because they would still be making some in-house.
If, on the other hand, they purchased 4,000 externally then although they would have extra costs of 4,000 x (12 – 10) = $8,000, they would save all of the fixed costs of $7,000. So the net extra cost would only be $1,000 (which is better than $2,000).
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