A firm's manager must decide whether to make or buy a certain item used in the production of vending machines . Making the item would involve annual lease costs of $ 150,000. Cost and volume estimates are as follows: a Given these numbers, shoud the firm buy or make this item ?

Question

A firm's manager must decide whether to make or buy a certain item used in the production of vending machines . Making the item would involve annual lease costs of $ 150,000. Cost and volume estimates are as follows:

	Make	Buy
Annual fixed cost	$ 150,000	None
Variable cost/unit	$ 60	$ 80
Annual volume (units)	12,000	12,000

a Given these numbers, shoud the firm buy or make this item ?

b. There is apossibility that volume could change in the future. At what volume would the manager be indifferent between making and buying?

Accepted Answer

a. Determine the annual cost of each alternative:

Total cost = Fixed cost + Volume × Variable cost

Make: $ 150,000 + 12,000($60) = $ 870,000

Buy: 0 + 12,000($80) = $960,000

Because the annual cost of marking the item is less than the annual cost of buying it, the manager would reasonably choose to make the iten . Note : If the unit cost to buy had been less than the variable cost to make, there would be no need to even consider fixed costs ; it would simply have been better to buy.

b. To determine the volume at which the two choices would be equivalent , set two total costs equal to each other and solve for volume: [latex]TC_{make}= TC_{buy}[/latex] Thus, $ 150,000 + Q($ 60) = 0 + Q($ 80). Solving, Q=7,500 units a year, the manager would be indifferent between making and buying . For lower volume, the choce would be to buy , and for higher volumes , the choice would be to make

Question 5.P.1: A firm's manager must decide whether to make or buy a certai...

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