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Kaplan F5 Exam KIT. Task ? 59. Page 23.
P is considering whether to continue making a component or to buy it from an outside supplier. It uses 12,000 of the components each year.
The internal manufacturing cost comprises:
Direct materials 3 £
Direct labour 4 £
Variable o/h-s 1 £
Specific FC 2,5 £
Other FC 2 £
Total: 12 £If the direct labour were not used to manufacture the component, it would be used to increase the production of another item for which there is unlimited demand. This other item has a contribution of 10,000 £ per unit but requires 8£ of labour per unit.
What is the maximum price per component, at which buying is preferable to internal manufacture?
A=8 £
B=10,5 £
C=12,5 £
D=15,5 £Kaplan provides us by working:
Relevant cost of labour=Contribution forgone+Direct Labour=10£/2+4£=9.
My Question 1 =>why contribution 10£ is divided by 2? What does it mean?
Then maximum price per components comprises from:
-direct materials 3 £
-direct labout 9 £
-variable o/h-s 1 £
-specific fc 2,5 £
Total: 15,5 £My Question 2 =>why maximum price does not include 2£ (other fixed costs).
Please help to resolve my non-understanding of these 2 questions.
In future, please ask in the Ask the Tutor Forum if you want me to answer.
The reason for dividing by 2 is effective a ‘key factor’ problem. Because the other item costs $8 a unit for labour, whereas the layout cost for the component is $4 a unit, it must mean that the other item is taking two times and many hours to make as the component.
Therefore every unit of the component that we make internally is taking labour that could be used to make half a unit of the other item, and therefore loses us half the contribution from the other unit.
Fixed costs are not relevant because we always assume (unless specifically told otherwise) that the total fixed costs of the business will stay unchanged whatever we do.
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