Question

The Shamrock Corporation produces and sells to wholesalers a highly successful line of summer lotion and insect repellents. Shamrock has decided to diversify to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin.

After considerable research, a winter products line has been developed. However, because of the conservative nature of company management, Shamrock’s president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated.

The product selected is a lip balm to be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for $8.00 per box. Because of available capacity, no additional fixed charges will be incurred to produce the product. However, a $180,000 fixed charge will be assigned to allocate a fair share of the company’s fixed costs to the new product. The remaining overhead costs are variable.

Using estimated sales and production of 100,000 boxes of lip balm as the standard volume, the accounting department has developed the following costs per box of 24 tubes:

Direct labour		$	4.40
Direct materials			6.60
Total overhead			3.20
Total		$	14.20

Shamrock approached a cosmetics manufacturer to discuss the possibility of purchasing the tubes for the new product. The purchase price of the empty tubes from the cosmetics manufacturer would be $2.02 per 24 tubes. If Shamrock accepts the purchase proposal, it is estimated that direct labour and variable overhead costs would be reduced by 10%, and direct materials costs would be reduced by 20%

Should the Shamrock Corporation make or buy the tubes?

		Make		Buy
Relevant cost:		$		$

Answer 1

Make or buy decisions completely depends on total cost. Whichever option has the lowest cost will be selected.

In the gives case company is currently engaged in inhouse manufacturing but the company wants to shift to outside purchase. Here the relevant cost of inhouse production will be the savings in cost if the company stops inhouse production and shifts to outside purchase.

Savings in cost if the company opts to buy:

Direct Labour [$4.40*10%] = $0.44

Direct Material [$6.60*20%] = $1.32

Total Overhead [$3.20*10%] = $0.32

Total relevant cost = $2.08

Cost of

Relevant cost to make = $2.08

Relevant cost to buy = $2.02

Since cost of purchase $2.02 is lower than cost of making $2.08, the company sjpuld opt for buying it from outside.