Question

A business is operating at 90% of capacity and is currently purchasing a part used in its manufacturing operations for $15 per unit. The unit cost for the business to make the part is $20 (including fixed costs), and $12 (not including fixed costs) Should this company make the part or buy it?

Answer 1

Purchase price = $15 per unit

Cost of making (including fixed cost) = $20 per unit

Cost of making (without fixed cost) = $12 per unit

Hence, on an average basis, fixed cost is $8 per unit.

Since the variable cost of making the part is less than the purchase cost, hence the part should be made in the factory and not bought from the outside supplier. Fixed cost of $8 per unit is irrelevant in deciding whether to make the component or to buy it from the outside supplier since it will have to be incurred in both the cases.

Hence, the part should be made.

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