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P is considering whether to continue making a component or to buy it from an outside supplier. It uses 12000 of the components each year.
Internal manufacturing cost comprises:
$ per unit:
DM – 3.00
DL – 4.00
V O/H – 1.00
Specific FCs – 2.50
Other FCs – 2.00Total – 12.50
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 $10.00 per unit but requires $8.00 of labour per unit.
What is the maximum price per component, at which buying is preferable to internal manufacture?
A. $8.00
B. $10.50
C. $12.50
D. $15.30My question:
Why is the answer D? My answer was C. I don’t understand why did the answer at the back divided the contribution with $10/2? And why is it + $4? Where did the $4 came from?
Not producing it themselves will save variable costs (and specific fixed overheads) of $10.50.
The other item they will be able to produce will give a contribution of $10, but will take twice as many hours to make (we know that, because the labour cost is twice as high).
So for every one if the current items we do not produce we will earn contribution from the other product of 10/2 = $5
Therefore the maximum to pay is 10.50 + 5 = $15.50.
(If answer D actually does say 15.30 then it is wrong – I assume it is just a typing mistake 🙂 )
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