Question

Structuring a Make-or-Buy Problem

Fresh Foods, a large restaurant chain, needs to determine if it would be cheaper to produce 5,000 units of its main food ingredient for use in its restaurants or to purchase them from an outside supplier for $12 each. Cost information on internal production includes the following:

	Total Cost		Unit Cost
Direct materials	$25,000		$ 5.00
Direct labor	15,000		3.00
Variable manufacturing overhead	7,500		1.50
Variable marketing overhead	10,000		2.00
Fixed plant overhead	30,000		6.00
Total	$87,500		$17.50

Fixed overhead will continue whether the ingredient is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price.

Answer 1

Fresh Foods What are the alternatives for Fresh Foods? Make the ingredient in house or buy it externally. Which alternative is more cost effective? Make the ingredient in-house Reason: Buy alternative Cost will be $12 x 5,000 units Add; Fixed plant Overhead Total cost 60000 30000 90000 Make alternative Direct materials Direct labor Variable manufacturing overhead Variable marketing overhead Fixed plant overhead Total 25000 15000 7500 10000 30000 87500 Make alternative is cost effective as it saves $2,500 ($90,000 - $87,500) of cost. Now assume that 20% of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost effective? Cost will be $12 x 5,000 units Add; Fixed plant Overhead (80%*30,000) Total cost 60000 24000 84000 Since making it in-house is not affected in this scenario, the cost will remain to be $87,500 Buy alternative will be cost effective since it will save a cost of $3,500 ($87,500 - $84,000).