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Hi John,
I’m a bit confused with the answer of this question from BPP revision Kit. I don’t understand why the products are ranked like that in the answer.
A company makes and sells four products. Direct labour hours are a scarce resource, but the company is able to sub-contract production of any products to external suppliers. The following information is relevant.
Product W X Y Z
Sales price 10 8 12 14
Variable cost 8 5 8 12
Cost of external purchase 9 7.1 10 13
Direct labour hours per unit 0.1 0.3 0.25 0.2In what order of priority should the company make these products in-house, rather than purchase tchem externally?
Answer
Product W X Y Z
Extra cost of external purchase $1 $2.1 $2 $1
Direct labour hours per unit 0.1 0.3 0.25 0.2
Extra cost per hour saved by
purchasing
$10 $7 $8 $5
Priority for external purchasing 4th 2nd 3rd 1st
Priority for making in-house 1st 3rd 2nd 4thFor product W, purchasing external costs $9 whereas making themselves costs $8. So if they make it themselves then they will save $1 per unit. Each unit will take them 0.1 hours to make, and so the saving is 1/0.1 = $10 per hour if they make themselves.
The same workings for each of the other products.
So with the hours they have available, they should use the to make the products that give the biggest savings – so W first, then Y, then X, then Z.When they run out of hours available, then the remainder will be purchased externally and will be the opposite order.
All of this is explained in my free lectures on make or buy. The lectures are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well.
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