Question

Hernandez, Inc. manufactures three models of picture frames for a total of 8,000 frames per year. The unit cost to produce a metal frame follows:

Direct materials		$ 6
Direct labor		8
Variable overhead		2
Fixed overhead (70% unavoidable)		5
	Total	$21

A local company has offered to supply Hernandez the 8,000 metal frames it needs for $17.20 each. Should Hernandez make or buy the metal framest?

Answer 1

Cost of making the product

Cost of making = $ 21 for a metal frame

Total cost of making 8000 frames = 21 * 8000 = 168,000

Cost of buying the product

Buying cost = 8000 * 17.20 + 70% ( 5 * 8000) = 137600 + 28000 = 165600

The unavoidable portion of making becomes a relavent cost for buying the product, since it is not avoided like material, labor and variable costs.

Decision : As the cost of buing is lower than, cost of making it is advisable to buy the product. Total saving to the company = 168000 - 165600 = $ 2400