Make or buy decisions

Masanzu Ltd is often faced with the decision as to whether it should manufacture a component
or buy it outside.

Masanzu Ltd. make four components, W, X, Y and Z, with expected costs for the coming year as follows:

W X Y Z
Production (units) 1,000 2,000 4,000 3,000
Unit marginal costs $ $ $ $
Direct materials 4 5 2 4
Direct labour 8 9 4 6
Variable production overheads 2 3 1 2

Direct fixed costs/annum and committed fixed costs are as follows:

Incurred as a direct consequence of making W 1,000

Incurred as a direct consequence of making X 5,000
Incurred as a direct consequence of making Y 6,000
Incurred as a direct consequence of making Z 8,000
Other committed fixed costs 30,000
50,000

A subcontractor has offered to supply units W, X, Y and Z for $12, $21, $10 and $14
respectively.

Decide whether Masanzu Ltd. should make or buy the components.

2. Make or buy

The Pip, a component used by Goya Manufacturing Ltd., is incorporated into a number of its
completed products. The Pip is purchased from a supplier at $2.50 per component and some
20,000 are used annually in production.

The price of $2.50 is considered to be competitive, and the supplier has maintained good quality
service over the last five years. The production engineering department at Goya Manufacturing
Ltd. has submitted a proposal to manufacture the Pip in-house. The variable cost per unit
produced is estimated at $1.20 and additional annual fixed costs that would be incurred if the
Pip were manufactured are estimated at $20,800.

a) Determine whether Goya Manufacturing Ltd. should continue to purchase the Pip or
manufacture it in-house.

b) Indicate the level of production required that would make Goya Manufacturing Ltd. decide in
favour of manufacturing the Pip itself.