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A company makes and sells four products. Direct labour hours are a scarce resource, but the company is
able to sub-contract production of any products to external suppliers. The following information is relevant.Sales price ($ per unit ) w=10, x=8, y=12, z=14
Variable cost w=8, x= 5, y=8, z=12
Cost of external purchase w=9, x=7.1, y=10, z=13
Direct labour hours per unit w=0.1,x=0.3, y=0.25, z=0.2In what order of priority should the company make these products in-house, rather than purchase them
externally?The answer given is W,Y,X,Z but from what i understood is that if i were to make the product, i would spend an extra $10 per unit for W, therefore it should be the last priority. The answer says otherwise. Hope to get a clearer explanation on this John. Thanks in advance!
The extra cost per unit of buying externally is:
W $1; X $2.1; Y $2 and Z $1Since labour is the scarce resource, we need to calculate the extra cost per labour hour, which are:
W $10; X $7; Y $8 and Z $5These are the costs per hour of buying externally, so we will buy externally the ones with the cheapest costs per hour, and make ourselves those with the lowest costs per hour.
So the answer is indeed correct. W is the most expensive to buy externally and therefore the one we will first make in-house, followed by Y then X then Z.
(Have you watched the free lectures on this? The lecture are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well 🙂 )
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