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A factory’s full capacity is used to make one product. the data is as follows:
Variable cost: 30,000
fixed cost:50,000if the entire production is outsourced, and another product is manufactured in the factory, this will yield a contribution of 50,000
what is the maximum price that should be paid for outsourcing the existing product?
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the answer is variable cost saved , 30,000, plus contribution earned of 50,000=80,000.
i dont understand this..:(
We will get the same revenue from the product whether we make it ourselves or whether we outsource it. So the revenue is irrelevant.
If we stop making it ourselves then we do not incur the variable cost – so we save 30,000.
If we do not make it ourselves then we can make the other product and earn a contribution of 50,000. So the benefit is 80,000 in total. However, we will obviously have to pay the company we outsource the production to – we can afford to pay them up to 80,000 and still be better off.(Fixed costs are ignored because we assume that the fixed costs of our factory will remain unchanged whichever product we make, and so will still be payable.)
ok.. thank you.
one more clarification: if we are given sales in units and in dollars and the questions says costs are allocated on “sales volume” basis, what does it mean? units or dollar value?
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