Make or Buy a Component
Current-Control, Inc., manufactures a variety of electrical switches. The company is currently manufacturing all of its own component parts. An outside supplier has offered to sell a switch to Current- Control for $32 per unit. To evaluate this offer, Current-Control, Inc., has gathered the following information relating to its own cost of producing the switch internally:
Per 12,000 Units
Unit per Year
Direct materials $12 $144,000
Direct labour 10 120,000
Variable manufacturing overhead 3 36,000
Fixed manufacturing overhead, traceable 8* 96,000
Fixed manufacturing overhead, common, but allocated 16 192,000
Total cost $49 $588,000
*25% supervisory salaries; 75% depreciation of special equipment (no resale value).
Required:
Assuming that the company has no alternative use for the facilities now being used to produce the switch, should the outside supplier's offer be accepted? Show all computations.
Suppose that if the switches were purchased, Current-Control, Inc., could use the freed capacity to launch a new product. The segment margin of the new product would be $78,000 per year. Should Current-Control, Inc., accept the offer to buy the switches from the outside supplier for $32 each? Show computations.
a) Make or buy :
| Make | Buy | |
| Direct material | 144000 | |
| Direct labour | 120000 | |
| Variable manufacturing overhead | 36000 | |
| Fixed manufacturing overhead (96000*25%) | 24000 | |
| Purchase cost (12000*32) | 384000 | |
| Total relevant cost | 324000 | 384000 |
Outside supplier's offer should not be accepted
b) Make or buy :
| Make | Buy | |
| Direct material | 144000 | |
| Direct labour | 120000 | |
| Variable manufacturing overhead | 36000 | |
| Fixed manufacturing overhead (96000*25%) | 24000 | |
| Opportunity cost | 78000 | |
| Purchase cost (12000*32) | 384000 | |
| Total relevant cost | 402000 | 384000 |
Outside supplier's offer should be accepted
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