A company is examining the cost of producing an item in-house rather than purcha
ID: 416495 • Letter: A
Question
A company is examining the cost of producing an item in-house rather than purchasing it from a 3
rd
party
supplier for $79.50/item. In-house production would require the one-time purchase of equipment of $2156
but the in-house production would cost only $2.50 per item. The demand for the item is a constant 10
items/week where one year is 52 weeks.
Question 1
. What is the break-even in weeks when the cost of the in-house option is equal to the cost of
the outsource option to the 3
rd
party?
(A) 28 (B) 2.8 (C) 25 (D) 2.5 (E) none of the above
Question 2.
What is the cost of the in-house option after one week?
(A) 2156 (B) 795 (C) 79.5 (D) 2181 (E) none of the above
Question 3.
Which option has the lowest cost after one week?
(A) outsource option (B) in-house option
Question 4.
Which option has the lowest cost after one year?
(A) outsource option (B) in-house option
Question 5
. After six months, what is the difference in cost between the in-house and outsource option?
(A) In-house option is $37884 more than the outsource option.
(B) In-house option is $17864 less than outsource option.
(C) In-house option is $17864 more than outsource option.
(D) In-house option is $37884 less than outsource option.
(E) None of the above statements is true.
Explanation / Answer
Answer to question 1 ;
Let the required production volume to break even = N
Cost of outsourcing for N items = $79.50.N
Cost of inhouse production for N items = One time purchase cost of equipment + $2.50 / item x N items = 2156 + 2.5.N
At break even point, cost of outsourcing N items = Cost of producing N items in house
Therefore,
79.5.N = 2156 + 2.5.N
Or, 77.N = 2156
Or, N = 2156 / 77 = 28 units
Thus breakeven quantity = 28 units
Weekly demand = 10 / week
Thus breakeven in weeks = 28 / 10 = 2.8 weeks
BREAKEVEN IN WEEKS = 2.8 WEEKS
Answer to question 2 :
Cost of in house option after 1 week
= One time purchase of equipment + Cost per unit x Weekly requirement
= $2156 + $25
= $2181
COST OF IN HOUSE OPTION AFTER 1 WEEK = $2181
Answer to question 3 ;
Total cost of outsourcing after 1 week = $79.50 / item x weekly requirement of 10 items = $795
Thus cost of outsourcing after 1 week ( $795) < Cost of making inhouse after 1 week ( $2181 )
OUTSOURCE OPTION HAS THE LOWEST COST AFTER 1 WEEK
Answer to question 4 :
Cost of outsource after 1 year ( 52 weeks or 520 items ) = $79.5 x 520 = $41340
Cost of in house option after 1 year ( 52 weeks of 520 items ) = 2156 + 2.5 x 520 = $2156 + $1300 = $3456
Cost of in house option ( $3456 ) < Cost of outsource ( $41340)
COST OF IN HOUSE OPTION HAS THE LOWEST COST AFTER 1 YEAR
Answer to question 5 :
Total number of items produced in 6 months or 26 weeks = 10 x 26 = 260 units
Total cost of outsourcing after six months = $79.50 x 260 = $20670
Total cost of making in house after six months = $2156 + $2.5 x 260 = $2156 + $650 = $2806
Thus,
Outsource option is higher than in house option by = $20670 - $2806 = $17864
ANSWER : B ) IN HOUSE OPTION IS $17864 LSS THAN OUTSOURCE OPTION
BREAKEVEN IN WEEKS = 2.8 WEEKS
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