Question

Currently, you make one of the components needed for final assembly of your product and you are considering buying the part from an outside supplier. You currently make the part on equipment that you have had for a number of years (but still runs fine) at a cost of $75,000 per year and a variable cost of $25.00 pre unit. The outside supplier that you found can make the part for $17.00 per unit, but you will have to pay some of their annual fixed costs of $220,000.

Required:
1. What is the break-even quantity (or indifference point) between buying and making? (Calculate by hand or all in Excel?)
2. What is the total cost to make a quantity of 28,000 units per year?
3. What is the total cost to buy a quantity of 28,000 units per year?
4. What does the company save for the year by selecting the low-cost option at an annual requirement of 28,000 units?

Answer 1

1. Break even quantity is 18,125 units

2. Cost to make 28,000 units = $ 775,000

3. Total costs to buy 28,000 units = $ 696,000

4. Savings by using low cost option ( buy from outside) $ 79,000

Step-by-step explanation:

Computation of Break even point

Variable cost to make equipment in house $ 25 per unit

Cost to purchase the unit from outside $ 17 per unit

Differential Cost per unit $ 8 per unit

Fixed costs to be paid to outside supplier $ 220,000

Fixed costs to be incurred in house $ 75,000

Incremental fixed costs $ 145,000

Break even point - Differential in fixed costs / Differential cost per unit

$ 145,000/ $ 8 = 18,125 units

Computation of costs to make 28,000 units

Variable costs per unit - $ 25 per unit

Units to be produced - 28,000 units

Total Variable costs $ 25 * 28,000 units $ 700,000

Fixed costs $ 75,000

Total costs to make 28,000 units $ 775,000

Computation of costs to buy 28,000 units

Variable costs per unit - $ 17 per unit

Units to be produced - 28,000 units

Total Variable costs $ 17 * 28,000 units $ 476,000

Fixed costs $ 220,000

Total costs to make 28,000 units $ 696,000

Computation of savings

Buying 28,000 units $ 775,000

Making 28,000 units $ 696,000

Savings from buying from outside $ 79,000