A firm currently makes a component, and requires 30 000 for the coming year's production. Another supplier has offered the part at a delivered price of $3 per unit. It would cost $3000 to check purchased units for quality. Product costs per unit for the past year were $2.35 variable and $1 fixed based on 30 000 units. If the component was bought, fixed overhead would be reduced by $6000, the cost of leasing specialised equipment. The space vacated by the equipment can be rented for $4000 for the year. At what level of units of production is the firm indifferent between making and buying?

Question

Quizplus · Accepted Answer

To determine the level of units of production where the firm is indifferent between making and buying, we need to calculate the Total Cost (TC) of both options and find where they are equal.

Make Option TC: 
Variable cost per unit = $2.35 
Fixed cost per unit = ($1 / 30,000 units) x 30,000 units = $1 
Total fixed overhead = $6,000 
Therefore, TC = (30,000 units x $2.35 per unit) + (30,000 units x $1 per unit) + $6,000 = $90,500

Buy Option TC: 
Delivered price per unit = $3 
Cost of checking purchased units for quality = $3,000 
Rent saved on vacated space = $4,000 
Therefore, TC = (30,000 units x $3 per unit) + $3,000 - $4,000 = $89,000

At 10,769 units of production, the make option TC would be:
Variable cost = 10,769 units x $2.35 per unit = $25,307.15
Fixed cost = ($1 / 30,000 units) x 10,769 units = $0.358967
Total fixed overhead = $6,000
Therefore, TC = $25,307.15 + $0.358967 + $6,000 = $31,308.11

At 10,769 units of production, the buy option TC would be:
Unit cost = $3 per unit
Total cost = 10,769 units x $3 per unit + $3,000 - $4,000 = $31,307

Since the buy option TC is lower at 10,769 units of production, the firm should choose to buy the component rather than make it.

A Firm Currently Makes a Component, and Requires 30 000