I.

Point of View
Incremental analysis is the process of identifying the financial data of that change under
alternative courses of action. These data are relevant to the management decision because they
will vary in the future among possible alternatives.
In make or buy decision, it is important for the management to take in consideration the
relevant costs. These costs are the (a) variable manufacturing costs that will be saved, (b) the
purchase price and (b) opportunity costs.
In our case TufStuff, Inc., which engaged in selling of a wide range of drums, bins, boxes
and other containers is considering on a possible alternatives on how to increase its revenues.
Alternatives are whether they will continue to manufacture their product WVD Drums or will just
purchase it at a lower price from other supplier Harcor Industries Inc., at $138.00 and still make a
profit since selling price will be remain the same at $149.00. Another option is to manufacture
the product Bike Frames instead of WVD Drums and can be sold at $239.00

Data’s presented

WVD DRUMS BIKE FRAMES

Selling Price per unit $ 149.00 $239.00

Costs:
Direct Materials $ 52.10 $ 99.40
Direct Labor ($18/hr) 3.60 28.80
Manufacturing OH 4.50 36.00
Selling and Admin Exp 29.80 90.00 47.80 212.00
Margin Per Unit $59.00 $27.00

Other important information

WVD DRUMS BIKE FRAMES
Make Buy Make
Welding hours per unit 0.40 0.00 0.50
Manufacturing OH per unit 1.35 0.00 1.90
Selling and Admin per unit 0.75 0.75 1.30

 A total of 2,000 hours of welding time available annually

 A limited annual production of 5,000 drums
 6,000 units of WVD drums required
 Harbor Industries INc. , supplier of quality drums can provide up to 4,000 WVD drums at $
138.00/drum
 1,600 Bike frames can sold @ $ 239.00
 All company’s employees –direct and indirect are paid for 40-hours workweeks and the
company has a policy of laying off workers only during major recessions.
II. Statement of the Problem

Main Problem

1. What will be the plan of Tufstuff Inc. to increase revenues?

A Make or Buy decision, whether the product be manufactured by the company or
purchased/outsource from external party/supplier.

Minor Problem

1. Maximization of contribution margins and rank products based on the contribution margin
per unit of the welding hours (constrained resource)

III. Objectives

1. To prepare a Make or Buy Analysis

2. To determine the best option whether to produce or acquire the WVD Drums for the
company to increase its revenues
3. To determine the best option whether to manufacture Bike frames instead of WVD Drums
to increase company revenues.

IV. Areas for Consideration

Make
Production Producing a part of the product
internally may ensure a smoother
transaction flow of parts and
materials for production. It may also
avoid reliance on the suppliers since
materials are on hand.
Buy
Time constraint for required
production, it is easier much
more convenient with instant
gratification.

Quality of the Product If the product is produced internally
inventory build-up and quality
control can be addressed easily
unlike in outsourcing from external
party, problem with the product may
arise.
If the product acquired,
company can choose or have
an option on what kind of
product they want to buy.
They can also have variety of
choices.

Profits Profits can be realized easily on the It can avoid other expenses.
parts and materials

Welding Hours Producing a product can incurred Overhead costs reduction.

additional costs.
V. Alternative Courses of Action

Guide questions for analysis of courses of action

1. Given the margins of two products as indicated in the reports submitted by accounting
department, does it make sense to consider producing the bike frames? Explain.

WVD DRUMS BIKE FRAMES

Selling Price per unit $ 149.00 $239.00

Costs:
Direct Materials $ 52.10 $ 99.40
Direct Labor ($18/hr) 3.60 28.80
Manufacturing OH 4.50 36.00
Selling and Admin Exp 29.80 90.00 47.80 212.00
Margin Per Unit $59.00 $27.00

Presented above product margins computed by the accounting department for the WVD drums and bike
frames should not be used in decision making on which product to be manufactured. The product margins
must be lower than they have computed because of the allocated fixed common costs. Likewise, the
important thing is the profitability of the two products in relation to the welding time (constraint resource)
usage. Thus, a product with a higher margin must maximize the usage of the welding time. Lastly
information presented by the accounting department is inadequate and maybe misleading for decision
making.

2. Compute the Contribution Margin per unit for

a. Purchased of WVD Drums

b. Manufacture WVD Drums
c. Manufacture Bike Frames

Assuming Direct Labor is Fixed Costs

Purchased WVD Manufactured WVD Manufactured BIKE

DRUMS DRUMS FRAMES

Selling Price per unit $149.00 $149.00 $239.00

Less Variable Costs:
Direct Materials 0.00 $ 52.10 $ 99.40
Manufacturing OH 0.00 1.35 1.90
Selling and Admin Exp 0.75 0.75 1.30
Purchase Price $ 138.00 138.75 0.00 54.20 0.00 102.60
Contribution Margin per Unit $10.25 $94.80 $136.40
 Purchased WVD Manufactured WVD CM/unit (Increase/
DRUMS DRUMS Decrease)

Selling Price per unit $149.00 $149.00 0.00

Less Variable Costs:

Direct Materials 0.00 $ 52.10 $ 52.10

Manufacturing OH 0.00 1.35 1.35
Selling and Admin Exp 0.75 0.75 0.0
Purchase Price $ 138.00 138.75 0.00 54.20 (138.00)
Contribution Margin per Unit $10.25 $94.80 ($88.45)

3. Determine the number of WVD drums that should be purchased and number of WVD drums and/or
bike frames that should be manufactured. What is the increase in net operating income that would
result from this plan over current operations?

Demand for welding machine hours exceeds the 2,000 hours capacity available. Thus, product that uses
machine hours most should be prioritized based on their contribution margin per welding hours.

Manufactured WVD DRUMS Manufactured BIKE FRAMES

Contribution Margin per Unit $94.80 $136.40
Welding Hours/Unit 0.40 0.5
Contribution Margin per Welding Hour $ 237.00 $ 272.80

Given that welding hours in manufacturing the bike frames is much bigger than of WVD Drums, the bike
frames should make use the most of the welding time. Thus, the company must produce more bike frames
to fill up the demand and will just use the remaining leftover capacity to make WVD drums. Then, to fill
up demand for WVD drums, this is the time the company may outsource it from other supplier.

Quantity CM/unit Welding Total Balance of Total CM (Q x

(Q) Time/Unit Welding Welding CM/unit)
(WT) Time ( Q x Time
WT)
Total Hours 2,000
Available /Capacity
Bike frames 1,600 $ 136.40 0.50 800 1,200 $ 218,240.00
produced
WVD Drums - make 3,000 94.80 0.40 1,200 0 284,400.00
WVD Drums - buy 3,000 10.25 0.00 0.00 0 30,750.00
Total CM 533,390.00
Less : Contribution Margin from the current operations: (474,000.00)
5,000 drums x $94.80 per drum
Increased in Contribution Margin and Net Operating Income $ 59,390.00
4. Redo requirements (2) and (3) making the opposite assumption about direct labor

Assuming Direct Labor is Variable Costs

Purchased WVD Manufactured WVD Manufactured BIKE

DRUMS DRUMS FRAMES

Selling Price per unit $149.00 $149.00 $239.00

Less Variable Costs:
Direct Materials $ 138.00 $ 52.10 $ 99.40
Direct Labor 0.00 3.60 28.80
Manufacturing OH 0.00 1.35 1.90
Selling and Admin Exp 0.75 138.75 0.75 57.80 1.30 131.40
Contribution Margin per Unit $10.25 $91.20 $107.60

Manufactured WVD DRUMS Manufactured BIKE FRAMES

Contribution Margin per Unit $91.20 $131.40
Welding Hours/Unit 0.40 0.5
Contribution Margin per Welding Hour $ 228.00 $ 215.20

When Direct Labor is treated as Variable Costs, the result is reversed of that with Direct Labor is treated
as Fixed Costs as computed above. Manufacturing WVD drums appear to be better in maximizing the
usage welding time compare of the bike frames.

Quantity CM/unit Welding Total Balance of Total CM (Q

(Q) Time/Unit Welding Welding x CM/unit)
(WT) Time ( Q x Time
WT)
Total Hours Available 2,000
WVD Drums - make 5,000 $ 91.20 0.40 2,000 0 $ 456,000.00
Bike frames produced 0 107.60 0.50 0 0 0
WVD Drums - buy 1,000 10.25 0.00 0.00 0 10,250.00
Total CM 466,250.00
Less : Contribution Margin from the current operations: (456,000.00)
5,000 drums x $91.20 per drum
Increased in Contribution Margin and Net Operating Income $ 10,250.00
5. What do you think is the correct way to treat direct labor cost in this situation – as variable costs or
as fixed costs?

Based on the computations, the case strongly agree that Direct Labor Costs must be treated as Fixed
Costs. As stated in the case “The bike frames could be produced with existing equipment and
personnel”. Employees also are paid in full for 40-hour workweeks.

Plan A :

Production Direct Labor Total Direct Labor

(Quantity) Hours per Unit Hours
Bike Frames - make 1,600 1.60* 2,560
WVD Drums -make 3,000 0.20** 600
TOTAL 3,160

Plan B:

Production Direct Labor Total Direct Labor

(Quantity) Hours per Unit Hours
WVD Drums -make 5,000 0.20** 1,000

*Direct Labor = $28.80 = 1.60 hours

Direct Labor per hour 18.00/hour

**Direct Labor = $3.60 = 0.20 hours

Direct Labor per hour 18.00/hour
Analysis of Courses of Action

Make Buy

You are in control of quality and cost of

Lower Labor Costs.
the product.

You'll have control over the production Eliminate the overhead cost associated
Advantages process with operating a manufacturing facility.

You reduce your production costs by Meet high demand of product.

purchasing materials directly from
manufacturers. Purchase on discounts on bulk orders.

Making your own products can be a time

consuming process, leaving you less time
Loss of Managerial Control
to focus on actually building your
business.
Disadvantages
Confidentiality could be compromised if
High Labor cost and overhead cost you're transmitting confidential
information

Lack of flexibility

VI. Conclusion and Recommendation

A company can maximize its contribution margin by focusing on the products with the greatest
amount of contribution margin per unit of the constrained resource ( welding hours in our case).
To get the option that could generate the highest profit, the company should be able to analyze
which product they should prioritize in production. The company should examine the alternative
choices based on the cost differences between them.

If production of bike frames will increase the net profit, then we highly recommend that the
company will produce the frames. However, if the numbers will be affected dramatically, then we
suggest that they stick to production of one product, and work with other supplier. On the other
hand, for the labor cost, we recommend that the company will consider all its labor cost to fixed
because of the fixed 40 hour workweek basis of employees’ salaries who are directly involved in
the production.
VII. Action Plan

Tufstuff Inc. should treat direct labor cost as a fixed cost because the company is paying its
employees in a fixed 40 hour workweek. To maximize profit in this option of using direct labor
cost as fixed cost, the company should produce first the bike frames at a full quantity of 1,600
which the company will be using 1,200 welding time. The remaining welding time will be used to
produce only 3,000 WVD drums. The remaining 3,000 WVD drums will be outsourced this is to
meet the demand of 6,000 WVD drums. With this setup, the company could increase their
contribution margin and net operating income by $ 59,390.00. This is the best option that the
company should consider in order to get the highest profits.