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 decide whether Cardinal should buy or make the part, we need to compare the total cost of making the part to the cost of buying it. The total cost of making the part is:

Direct materials + Direct labor + Variable overhead + Fixed overhead applied

= $4 + $17 + $7 + $10

= $38

The cost of buying the part from Oriole is $42.

Since the cost of buying the part is higher than the total cost of making it, it would be more cost-effective for Cardinal to make the part rather than buy it.

However, it is important to note that 60% of the fixed overhead applied will continue regardless of what decision is made. This means that if Cardinal decides to buy the part, it will still incur 60% of the fixed overhead cost, which will increase the total cost of buying the part to:

Cost of buying the part + 60% of fixed overhead applied

= $42 + (60% x $10)

= $48

Even with the additional fixed overhead cost, the total cost of buying the part is still higher than the cost of making it. Therefore, it would still be more cost-effective for Cardinal to make the part rather than buy it.

Answer 2

The Cardinal Company should make the part internally as the cost to make ($32 per unit, considering the unavoidable fixed overhead) is less than the cost to buy ($42 per unit).

Step-by-step explanation:

The Cardinal Company needs to decide whether to make or buy a part needed for their production cycle. When considering whether to make the product, the total internal cost amounts to $38 per unit, which includes direct materials, direct labor, variable overhead, and fixed overhead. However, if the part is purchased from the Oriole Company, it would cost $42 per unit. It's important to note that 60% of the fixed overhead will still be incurred even if they decide to buy the part. Therefore, the relevant cost of making the part internally deducts the unavoidable fixed overhead (60% of $10, which is $6), resulting in a comparative production cost of $32 ($38 - $6). Since this cost is lower than the $42 needed to buy the part, it would be more cost-effective for the Cardinal Company to produce the part internally.

In summary, it's advised that the Cardinal Company should make the part internally as the costs are lower when compared to buying it from the Oriole Company, considering the unavoidable fixed overhead.