Question

Fresh Foods, a large restaurant chain, needed to determine if it would be cheaper to produce 5,000 units of its main food ingredient for use in its restaurants or to purchase them from an outside supplier for $12 each. Cost information on internal production includes the following: Total Cost Unit CostDirect materials $25,000 $5.00Direct labor 15,000 3.00Variable manufacturing overhead 7,500 1.50Variable marketing overhead 9,500 1.90Fixed plant overhead 30,000 6.00Total $87,000 $17.40Fixed overhead will continue whether the ingredient is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price. If required, round your answers to the nearest whole number.Required:1. What are the alternatives for Fresh Foods?Make the ingredient in house or buy it externally.2. Which alternative is more cost effective and by how much? (Use total cost when giving your answer.)Make $ 3. Now assume that 40% of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost effective and by how much? (Use total cost when giving your answer.)Buy $

Answer 1

Answer:

Fresh Foods

Make or Buy Decision:

1. Make the ingredient in-house.

2. Make in-house is more cost effective by $3,000 ($90,000 - 87,000)

3. If 40% of the fixed overhead can be avoided if the ingredient is purchased externally:

Total cost:

To make in-house = $87,000

To buy = $78,000 ($60,000 + $30,000 x 60%)

To buy now becomes more cost effective by $9,000 ($87,000 - 78,000).

Explanation:

a) Management in production companies are always faced with the buy or make decision.  For this type of decision making, the appropriate costs to analyze are the differential (incremental) costs.  These are costs that make a difference between alternatives.

b) Calculation of cost:

                                                                  Make                  Buy

                                                        Total            Unit

Purchase                                                                              $60,000

Direct materials                           $25,000     $5.00

Direct labor                                     15,000       3.00

Variable manufacturing overhead  7,500        1.50

Variable marketing overhead         9,500        1.90

Fixed plant overhead                    30,000       6.00            30,000

Total                                             $87,000    $17.40         $90,000

Total variable costs                     $57,000                        $60,000