Question

Waterways Continuing Problem 07 (Part 2) Waterways has discovered that a small fitting it now manufactures at a cost of $1.00 per unit could be bought elsewhere for $0.81 per unit. Waterways has fixed costs of $0.20 per unit that cannot be eliminated by buying this unit. Waterways needs 428,000 of these units each year. If Waterways decides to buy rather than produce the small fitting, it can devote the machinery and labor to making a timing unit it now buys from another company. Waterways uses approximately 500 of these units each year. The cost of the unit is $12.23. To aid in the production of this unit, Waterways would need to purchase a new machine at a cost of $2,326, and the cost of producing the units would be $10.40 a unit.

What is Waterways’ opportunity cost if it chooses to buy the small fitting and start manufacturing the timing unit?

The opportunity cost is

$

Would it be wise for Waterways to buy the fitting and manufacture the timing unit? The company should makebuy small fittings and makebuy the timing units. Without considering the possibility of making the timing unit, evaluate whether Waterways should buy or continue to make the small fitting. The company should buymake the fitting. Incremental cost / (savings) will be $

Answer 1

What is Waterways’ opportunity cost if it chooses to buy the small fitting and start manufacturing the timing unit?

Ans: Opportunity cost is the monetory loss due to choosing one alternative over other. Here when company choose to buy fitting equipment it will pay 0.81 per unit i.e. 0.01 over its manufacturing cost of 0.80 (1.00-0.20). Fixed cost of .20 is irrelevant as it is going to occur irrespective of any choice made.

The opportunity cost is (428000* 0.01) = $4280

Would it be wise for Waterways to buy the fitting and manufacture the timing unit

Ans.

	Total opportunity cost due to purchasing small Fitting		4280
	Savings due to manufacturing timing unit
	Production cost	(500*10.4)	5200
Add:	Cost of machine		2326
	(capacity or life of machine is not given so added in full here)
	Total mfg cost		7526
	Purchse cost	(500*12.23)	6115

here as we can see the purchase cost is lower than manufacturing cost for Timing unit and there is opportunity cost from purchase of small fitting so the compnay should continue ot make small fitting and buy the timing unit.

small Fitting : Manufacture

Timing unit: Buy

Without considering the possibility of making the timing unit, evaluate whether Waterways should buy or continue to make the small fitting?

Ans: We have already seen than if company choose buy over manufacturing of small fitting it has to pay extra $4280 which it could save by manufactuing the same. So it should continue to manufacture small fitting and leading to savins of $4280.