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Hi, could you help me with a question please: p is considering weather to continue making a component or buy it from outside supplier. It uses 1200 of th components each year. Internal manufactoring cost p.u.: dir.mat $3, labour 4, var overheads 1, specific fix cost 2.50, other fix cost 2. Total 12.50. If the direct labour were not used to manufact.the component, it would be used to increase the production of another item for which there is unlimited demand, this other item has a contrib $10p u but requires $8 of labour per unit. What is the max price per component at which buying is preferable to internal manufacture? The answer is$15.50 but i dont undestand how to arrive to this answer. Please help. Many thanks in advance. Irina
If the buy externally and do not make it themselves, then they will save the variable costs and the specific fixed costs. So they will save a total of 1,200 x (3 + 4 + 1 + 2.5) = $12,600.
In addition they would earn contribution from the other item they would produce. However since the other item requires $8 labour per unit, and the existing component only requires labour of $4 per units, the other item must take twice as long to make.
So releasing the labour from the existing 1,200 units will give them enough time to make 600 units of the other item, so the would get a total contribution of 600 x $10 = $6,000.So the total benefit of buying externally is 12,600 + 6,000 = $18,600.
It would therefore be better to buy externally if they can buy the 1,200 units for a maximum of $18,600.
$18,600 / 1,200 = $15.50 per unit.
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