Hahn Manufacturing purchases a key component of one of its products from a local supplier. The current purchase price is $1.500 per unit. Efforts to standardize parts succeeded to the point that this same component can now be used in five different products. Annual component usage should increase from 150 to 750 units. Management wonders whether it is time to make the component in-house, rather than to continue buying it from the supplier. Fixed costs would increase by about $40,000 per year for the new equipment and tooling needed. The cost of raw materials and variable overhead would be about $1,100 per unit, and labor costs would be $300 per unit produced.
Should Hahn make rather than buy?
What is the break-even quantity?
c. What other considerations might be important?
The Correct Answer and Explanation is :
Decision: Make or Buy?
- Cost Analysis
To decide, Hahn Manufacturing should compare the total costs of making versus buying the component.
- Buying cost per year:
Current purchase price = $1,500 per unit
Annual usage = 750 units
Total buying cost = ( 1,500 \times 750 = 1,125,000 ) - Making cost per year:
Fixed costs = $40,000/year
Variable cost per unit = $1,100 (raw materials & variable overhead) + $300 (labor) = $1,400/unit
Total making cost = ( 40,000 + (1,400 \times 750) = 40,000 + 1,050,000 = 1,090,000 ) Since the making cost ($1,090,000) is less than the buying cost ($1,125,000), Hahn should make the component in-house.
- Break-Even Quantity
The break-even point occurs where the total cost of making equals the total cost of buying. Let ( Q ) be the break-even quantity:
[
1,500Q = 40,000 + 1,400Q
]
Solving for ( Q ):
[
Q = \frac{40,000}{1,500 – 1,400} = \frac{40,000}{100} = 400 \, \text{units}
] If annual demand exceeds 400 units, it is more economical to make the component.
- Other Considerations
- Quality Control: Can the in-house production maintain or improve quality compared to the supplier?
- Capacity and Expertise: Does Hahn have the required expertise, space, and capacity for production?
- Future Demand: Will demand stay consistent or increase beyond 750 units, making in-house production more cost-effective over time?
- Supplier Relations: Cutting ties with the supplier might affect other business relationships.
- Flexibility: Making components in-house could limit flexibility if demand drops.
In conclusion, Hahn should make the component if it anticipates stable or growing demand and can ensure quality and capacity. The break-even quantity of 400 units indicates a strong financial case for in-house production at the current usage level.