Company is considering buying a part next year that they currently make. This ye

Question

Company is considering buying a part next year that they currently make. This year's production costs for 3,400 units were:

A company has offered to supply this part for $12.89 per unit. If X Company buys the part, $8,109 of the fixed overhead can be avoided. Also if X Company buys the part, it can use the freed-up resources to increase production of another product, resulting in additional contribution margin of $2,800. X Company is uncertain what production will be next year. At what production level would it be indifferent between making and buying the part?

Total   Per-Unit Materials $11,424 $3.36    Direct labor [all variable] 12,920 3.80    Variable overhead 11,560 3.40    Fixed overhead 15,300 4.50   

Explanation / Answer

We need to use the following cost equations to arrive ath the production level at which the company will be indifferent between making and buying.

Let us assume that X represents the production level.

Make Equation = 10.56X (Indicates Variable Portion) + 15,300 (Indicates Fixed Overhead Portion) + 2,800 (Loss of Contribution Margin)

Buy Equation = 12.89X (Indicates the Purchase Price) + (15,300 - 8,109) [Indicates Unavoidable Overhead Cost]

Now, we need to equate these equations and solve for X as follows:

10.56X + 15,300 + 2,800 = 12.89X + 7,191

Solving further, we get,

X = (15,300 + 2,800 - 7,191)/(12.89 - 10.56) = 4,682 units

At a production level of 4,682 units, the company would it be indifferent between making and buying the part.

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