Question

A manager is trying to decide whether to purchase a certain part or to have it produced internally. Internal production could use either of two processes. One would entail a variable cost of $17 per unit and an annual fixed cost of $200,000; the other would entail a variable cost of $14 per unit and an annual fixed cost of $240,000. Three vendors are willing to provide the part. Vendor A has a price of $20 per unit for any volume up to 30,000 units. Vendor B has a price of $22 per unit for demand of 1,000 units or less, and $18 per unit for larger quantities. Vendor C offers a price of $21 per unit for the first 1,000 units, and $19 per unit for additional units.
A. If the manager anticipates an annual volume of 10,000 units, which alternative would be best from a cost standpoint? For 20,000 units, which alternative would be best?
B. Determine the range for which each alternative is best. Are there any alternatives that are never best? Which?
TC for 10,000 units TC for 20,000 units
Int. 1: $ Int. 1: $
Int. 2: $ Int. 2: $
Vend A $ Vend A $
Vend B $ Vend B $
Vend C $ Vend C $

Answer 1

Answer:

A.  If the manager anticipates an annual volume of 10,000 units, the alternative that would be best from a cost standpoint is Vendor B.

Again, for annual volume of 20,000 units, Vendor B is the best choice.

B. For Process I, it is best within the range of 20,555 and 200,000

For Process 2, the best range is 200,000 and above

Vender A, there is no best range

Vender B, the best range is 1 to 20,555

Vender C, there is no best range

Explanation:

a) Data and Calculations:

Internal Process 1 = $17Q + $200,000

Internal Process 2 = $14Q + $240,000

Vendor A = $20Q up to 30,000 units

Vender B = $18Q

Vender C = $21*1,000 + $19(Q-1,000)

Calculation of total cost under each alternative:

                                                  Internal      Vender A  Vender B   Vender C

                                 Process 1  Process 2

Cost of production:

Variable cost per unit    $17          $14             $20            $18            $19

For 10,000 Units:

Fixed costs              $200,000  $240,000        0               0             $21,000

Variable cost              170,000      140,000  $200,000 $180,000   $171,000

Total cost                $370,000   $380,000  $200,000  $180,000 $192,000

For 20,000 units:

Fixed costs            $200,000  $240,000        0               0             $21,000

Variable cost            340,000    280,000  $400,000  $360,000  $361,000

Total cost              $540,000  $520,000  $400,000  $360,000 $382,000