A guide to assignment on the case study of a vacum manufacturer performing make or buy decision. This includes calculating total product cost with fixed and variable cost, and cost to buy. Comparision and conclusion with sufficient references is given.
Please describe the circumstances of the following case study and recommend a course of action.
Explain your approach to the problem, perform relevant calculations and analysis, and formulate
a recommendation. Ensure your work and recommendation are thoroughly supported.
Case Study:
A vacuum manufacturer has prepared the following cost data for manufacturing one of its engine
components based on the annual production of 50,000 units.
Description Cost per Month
Direct Materials $75,000
Direct Labor $100,000
Total $175,000
In addition, variable factory overhead is applied at $7.50 per unit. Fixed factory overhead is
applied at 150% of direct labor cost per unit. The vacuums sell for $150 each. A third party has
offered to make the engines for $60 per unit. 75% of fixed factory overhead, which represents
executive salaries, rent, depreciation, and taxes, continue regardless of the decision. Should the
company make or buy the engines?
Superior papers will:
Perform all calculations correctly.
, Articulate the approach to solving the problem, including which financial information is
relevant and not relevant.
Correctly conclude on whether the company should make or buy the engines.
Propose other factors that should be considered when making this decision and elaborate on
whether or not those factors do or do not support the decision.
Case Study: Vacuum Manufacturer
The first task is to divide the costs and revenue into differential and not differential. A difference
in cost between any two alternatives is known as differential cost (Ali, 2014). A difference in
revenue between any two alternatives is known as differential revenues (Ali, 2014). The vacuum
manufacturer has two alternatives one is to make or buy from a third party which is commonly
referred to as a Make or Buy decision.
Direct material and direct labor costs are differential costs since they will be eliminated if the
company buys the component from a third party. The variable factory overhead will also be
eliminated if the company chooses to buy from a third party. Variable overhead refers to the
fluctuation in the manufacturing costs associated with the operation of businesses (Corporate
Finance Institute, 2020a). Additionally, a portion of the fixed factory overhead will be
eliminated.
However, 75% of the fixed factory overhead will continue regardless of the outsourcing meaning
this portion will not be considered differential. The revenue comes from selling the vacuum
however since it would be similar for both alternatives it would be excluded from the analysis.
Once we have categorized the costs we need to convert the direct costs into a unit-based rather
than monthly for ease of analysis.
The company annual production is 50,000 units and the direct material cost per month is $75,000
while the direct labor cost is $100,000 per month. A direct cost is a price that can be directly tied
to the production of specific goods or services (Kenton, 2020b). Since both of these costs are
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