Question

You make component X in-house at a cost of $16 per unit, which consists of $2 direct labor per unit, $7 direct materials per unit, $2 fixed overhead per unit, and $5 variable overhead per unit. You need 1,000 units of X per month. An outside supplier has offered to sell component X to you at $12 per unit. If you outsource the production of X to the supplier, how much will your profit change in the short term

Answer 1

Answer:

Change in profit is Nil

Explanation:

To determine whether to outsource the production of product X or not, we would compare the variable cost internal production to the external purchase price. And then adjust  the net figure for the fixed costs.

For a make or buy decision the relevant cash flows include

1. the differential variable cost of the two options  

2. savings from avoidable fixed costs associated with internal production

                                                                                                  $

Variable cost internal production (2+7+5)                             14

External buy in price                                                               12    

Savings per unit  of bought from outside                             2  

Savings on  1000 units (2× 1,000)                                         2,000

Unavoidable  fixed cost (2  ×    1,000)                                 (2,000)    

Net change in profit                                                                   Nil  

Note we assume that the fixed overhead is unavoidable. That is it will still be incurred whether or the product is outsourced