Question

Space W Inc. manufacturers specialized aerospace parts. A subcontracting opportunity (buying) of providing 2,000 units of Part XCM for $120 000 is being considered. The internal price of Part XCM is as follows;

	Cost per unit
Direct materials	$28
Direct labour	18
Variable Overhead	16
Allocated fixed overhead	4

1. What is the relevant cost (per unit, RND 2 decimal places) to make the part internally?
2. What is the estimated increase/decrease in short-term operating profit of producing the product internally versus purchasing the product from a supplier? RND to whole dollars
3. What other strategic considerations should be reviewed for this make/buy decision?

Answer 1

a) In relevant cost we consider only variable cost of the product. So, Relevant cost to make the part internally is

Relevant Cost=( Direct Material + Direct Labour+ Variable Overhead) *2000 units

=(28+18+16)*2000

=$124000 i.e $62/unit

b)If Space W Inc decides to manufacture the Part XCM internally it will decrease the operating profit by $4000(124000-120000).

However,If Space W Inc decides to Purchase the Part XCM it will increase the operating profit by $4000(124000-120000).

c)Apart from financial consideration the Space W Inc shall review following non financial considerations:-

• Whether quality produced by sub contractor matches the quality to be used in the product.
• Delivery time taken to deliver Part XCM by sub contractor.
• Fault in parts delivered by sub contractor.
• Credit terms provided to Space W Inc.