Answer:
Make or Buy Decisions:
a) Make (50,000 units)
Direct materials $75,000
Direct labor 100,000
Variable overhead 375,000
Total variable costs $550,000
Contribution $6,950,000
Sales $7,500,000
Fixed overhead 150,000
Net profit $7,350,000
b) Buy (50,000):
Purchase price $3,000,000
Contribution $4,500,000
Fixed costs 112,500
Net profit $4,387,500
c) The company should make the engines.
Explanation:
a) Variable overhead = $375,000 ($7.50 x 50,000)
b) Fixed overhead = $150,000 ($100,000 x 1.5)
c) Sales = $7,500,000 ($150 x 50,000)
d) Purchase = $3,000,000 ($60 x 50,000)
e) Unavoidable Fixed overhead = $112,500 ($150,000 x 75%)
f) The problem is called a make or buy decision because, management of this company is faced with two options. In order to arrive at the better option in terms of long-term financial implication, the costs and profitability of the decision must be taken into consideration. Relevant costs are considered. A look at the two options, clearly shows that it makes better financial sense for the company to make than to buy the engines outside. Therefore, management is advised to make as the company will make much more sustainable profit by so doing.
