Question

Please explain how the answer was obtained. thanks

Given the following data:

Units Produced: 10,000
Direct Materials cost per unit: $5
Direct Labor cost per unit: $4
Variable Overhead Costs per unit: $3
Fixed Overhead costs per unit: $6 (will not change)

Purchase Price per unit if bought: $15
Additional rent revenue generated if the product is bought: $35,000

Should the company make or buy the product?

A) Make the product because it will save $30,000

B) Buy the product because it wil save $30,000

C) Make the product because it will save $5,000

D) Buy the product because it will save $5,000

Answer 1

D) Buy the product because it will save $5,000

Working:

Step-1:Relevant cost of making the product
	Direct materials cost per unit				$               5.00
	Direct Labor cost per unit				$               4.00
	Variable overhead costs per unit				$               3.00
	Total variable cost per unit				$             12.00
	Total units produced				10,000
	Total variable cost of units produced				$       1,20,000
	Opportunity cost (Rent revenue)				$           35,000
	Total relevant cost of making the product				$       1,55,000
Note:
Opportunity cost is the benefit foregone by choosing one alternative over other.
By making the product, rent revenue is lost.So, it is opportunity cost.
Further, fixed cost does not change by any decision.So, it is not relevant for decision making.
Step-2:Calculation of buying cost
	Buying cost		=	10000*15	=	$       1,50,000
Since total cost of buying is less than making.So, making the product will save $ 5,000.