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In-house production capacity is 8000 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.
Material W X Y Z
Units required 4000 2000 3000 4000
Variable cost of in-house $8/unit $12/unit $9/unit $10/unit
manufacture
Directly attributable $5000 $8000 $6000 $7000
fixed cost expenditure
Cost of external purchase $9/unit $18/unit $12/unit $12/unitDirectly attributable fixed costs are fixed cash expenditures that can be saved if production of the material in-house is stopped entirely.
If a decision is made solely on the basis of short-term cost considerations, what materials should the company purchase externally?
Answer: 4000 units of W and 4000 units of Z.
I don’t understand why 4000 units of Z? Why is it not 1000 units of Z?
Please help clarify…If they purchased 1,000 units of Z externally it would cost an extra 1,000 x $2 = $2,000 but they would not save any of the directly attributable fixed costs because they would still be making some internally.
If, alternatively, they purchased all 4,000 externally then it would cost an extra $8,000 but they would then save all of the directly attributable fixed costs of $7,000. So the net extra cost is $1,000 (which is better than an extra cost of $2,000 🙂 )
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