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- This topic has 3 replies, 2 voices, and was last updated 2 years ago by
John Moffat.
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- May 26, 2022 at 5:22 pm #656514
30
A company wants to decide whether to make its materials in-house or whether 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
$5,500 $8,000 $6,000 $7,000
Cost of external
purchase $9 per unit $18 per unit $12 per unit $12 per unitRequired
If a decision is made solely on the basis of short-term cost considerations, what materials should
the company purchase externally?
? 4,000 units of W and 1,000 units of Z
? 4,000 units of W and 4,000 units of Z
? 3,000 units of Y and 2,000 units of Z
? 1,000 units of Y and 4,000 units of ZAnswer
The correct answer is:
4,000 units of W and 4,000 units of Z
Good day sir,I don’t understand why 4000 units of Z is to be purchased externally when there is spare capacity for 3000 units to be produced internally.May 27, 2022 at 8:28 am #656617The trick in this question is that the directly attributable fixed costs will have to be paid if any of the units of the relevant product are being produced in house.
If any of product Z were produced in house then they would still have to pay the full directly attributable costs. It is only if they produce none of product Z that they will save all of the $7,000.
May 27, 2022 at 10:50 pm #656669Thank you sir
May 28, 2022 at 7:51 am #656702You are welcome 🙂
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