Make-buy George INC manufactures parts for hats. The CEO is considering an offer

ID: 2481445 • Letter: M

Question

Make-buy

George INC manufactures parts for hats. The CEO is considering an offer from a subcontractor who would provide 2,800 units of cloth for a price of $190,000 (these are extremely nice hats). If George INC does not purchase these parts from the subcontractor it must produce them in-house with the following costs:

Direct Materials $22

Direct Labor 18

Variable Overhead 14

Allocated Fixed Factory Overhead 16

Allocated Fixed Selling Costs 5

Total Cost $75

If George INC produces the part, there would also be incremental fixed costs of $13,000 per period. Should George INC accept the offer from the subcontractor?

(please show workout)

Explanation / Answer

Solution:

Statement of Analysis

Make in house

Buy from Sub-contractor

Direct Material (2800*22)

$61,600

Cost of Buying the material from Sub-Contractor $190,000

Direct Labor (2800*18)

$50,400

Variable Overhead (2800*14)

$39,200

Additional Fixed Cost

$13,000

Total Relevant Cost

$164,200

$190,000

Since cost of buying from outside is more expensive than making in house the units of cloth.

The sub-contractor offer should not be accepted.

Note --- Fixed Costs are sunk costs that have already been incurred and hence not relevant for decision making.