Structuring a Make-or-Buy Problem
Fresh Foods, a large restaurant chain, needed to determine if it would be cheaper to produce 5,000 units of its main food ingredient for use in its restaurants or to purchase them from an outside supplier for $12 each. Cost information on internal production includes the following:
|Total Cost||Unit Cost|
|Direct materials||$25,000||$ 5.00|
|Variable manufacturing overhead||7,500||1.50|
|Variable marketing overhead||10,000||2.00|
|Fixed plant overhead||30,000||6.00|
Fixed overhead will continue whether the ingredient is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price.
1. What are the alternatives for Fresh Foods?
Make the ingredient in house or buy it externally.
2. Which alternative is more cost effective?
Make the ingredient in-house
By how much?
3. Now assume that 20% of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost effective?
By how much?
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