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A company wants to decide whether to make its material in house or whether to sub contract production to external supplier
Prodcution capacity 8000 unitsMaterial w x y z
Units require 4000 2000 3000 4000
V/cost in 8$ 12$ 9$ 10$
Fix/oh expe 5000 8000 6000 7000
Cost of exter 9$ 18$ 12$ 12$Fixed cost are fixed cash expenditure that would be saved if production of the material in house stopped entirely
If a decision is made solely on the basis of short term cost consideration what material should the company purchase externally
1.4000 units of w and 1000 units of z
2.4000 units of w and 4000 units of z
3.3000 units of y and 2000 units of z
4.1000 units of y and 4000 units of z
Why the answer in not 1
I thought the capacity is 8000 so they can make 3000 of z in house which is cheaper and 1000 externally because there is no capacityYour answer would be correct were it not for the fact that the fixed overhead expenditure is saved for any products that are purchased entirely externally.
I assume that you found this question in the BPP Revision Kit, in which case you will see the full explanation in their answer.
It is only buying W externally that would result in an actual saving (it would cost 4,000 x $1 to buy externally, but they would save $5,000 in fixed costs, so by buying W externally they would save $1,000. Buying any of the others would result in a net extra cost, so they will definitely buy W externally.
That leaves 4,000 remaining capacity. If they make 3,000 of Z in house, then they will not save any fixed overheads. It is better to buy all 4,000 of Z externally because they will then save the fixed overheads and the extra cost will only be $1,000 (which is less than the extra cost of the other two products).
Thank you sir, sometimes the answer in the revision kit seem so vague but now i understand
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