Make or Buy Cost Decision
The quoted price for a certain part is $20.00 per unit for 100 units. The part can be produced in the company’s own plant for $28.00. The cost components of making the part are as follows:

Question

Unit raw material cost = $8.00 per unit
Direct labor cost = $6.00 per unit
Labor overhead at 150% = $9.00 per unit
[latex] ext{Equipment fixed cost} = \underline{\$5.00 ext{per unit}}[/latex]

Total = $28.00 per unit

Should the part be bought or made in-house?

Accepted Answer

Although the vendor’s quote seems to favor a buy decision, consider the
possible impact on plant operations if the quote is accepted. Equipment fixed cost of $5.00 is an allocated cost based on an investment that was already made.
If the equipment designated for this job is not utilized because of a decision to purchase the part, then the fixed cost continues even if the equipment stands idle. In the same way, the labor overhead cost of $9.00 consists of factory space, utility, and labor costs that remain even if the part is purchased. In addition, there are the costs of purchasing and receiving inspection. By this reasoning, a buy decision is not a good decision because it might cost the company $20.00 + $5.00 + $9.00 = $34.00 per unit (not including purchasing and receiving inspection) if it results in idle time on the machine that would have been used to produce the part. On the other hand, if the equipment in question can be used to produce other parts for which the in-house costs are less than the corresponding outside quotes, then a buy decision is a good decision.

Question 24.1: Make or Buy Cost Decision The quoted price for a certain par...