Question

8. Cardinal Company needs 20,000 units of a certain part to use in its production cycle. The following information is available:

Cost of cardinal to make the part:
Direct materials $4
Direct labor 17
Variable overhead 7
Fixed overhead 10
$38
Cost to buy the part from the Oriole company $42

If Cardinal buys the part from Oriole instead of making it, Cardinal could not use the released facilities in another manufacturing activity. Sixty percent of the fixed overhead applied will continue, regardless of what decision is made.
What do you advise to the firm managers: shall the firm buy or make the product?

Answer 1

To determine whether Cardinal should make or buy the part, we need to compare the total cost of making the part with the cost of buying the part.

The cost of making the part is:

Direct materials + Direct labor + Variable overhead + Fixed overhead applied = $4 + $17 + $7 + $10 = $38 per unit

The cost of buying the part is $42 per unit.

Since the cost of buying the part is greater than the cost of making it, Cardinal should make the part.

However, we also need to consider the fixed overhead that will continue regardless of what decision is made. Sixty percent of the fixed overhead applied will continue, so the relevant cost of making the part is:

Direct materials + Direct labor + Variable overhead + (60% x Fixed overhead applied) = $4 + $17 + $7 + (0.6 x $10) = $33.60 per unit

Since the relevant cost of making the part is less than the cost of buying it, Cardinal should make the part.

Therefore, based on the cost analysis, it is advisable for Cardinal to make the part rather than buying it.