Question

David is trying to decide if it makes sense to outsource the purchasing function. He has a chain of 12 restaurants and employs two buyers at an annual fixed cost of $85,000. David estimates that the variable cost of each purchase order placed is $15. An outsourced company will perform the purchasing function for a fixed annual fee of $100,000 plus $5 for each purchase order placed. Last year, David placed 1400 purchase orders.
Required:
a. What was the in-house purchasing cost last year?
b. What would the cost be if outsourced?
c. If David estimates it will place 1600 purchase orders next year, should he outsourced?

Answer 1

Answer and Explanation:

The computation is shown below;

a) The In-house purchasing cost last year is

= Fixed costs + Variable costs

 =$85,000 + Total number of purchase orders × cost per order

 = $85,000 + 1400 × 15

= $106,000

b)

The outsourcing cost is

Outsourcing cost = Fixed costs +Variable costs

 = $100,000 + Total number of purchase orders × cost per order

= $100,000 + 1400 × 5

 = $107,000

c) Total number of purchase orders = 1600

In-house purchasing cost = 85,000 + 1600 × $15 = $109000

Outsourcing cost = $100,000 + 1600 × $5 = $108000

Yes, David should outsource as the outsourcing cost is less than the in-house purchasing cost.