Make-or-Buy Decision
Pizana Computer Company has been purchasing carrying cases for its portable computers at a purchase price of $55 per unit. The company, which is currently operating below full capacity, charges factory overhead to production at the rate of 36% of direct labor cost. The unit costs to produce comparable carrying cases are expected to be as follows:
The Correct Answer and Explanation is:
To assist with a make-or-buy decision, we compare the relevant costs of making the product in-house versus buying it from an external supplier. Here’s the detailed cost comparison for Pizana Computer Company:
Given:
- Purchase price from supplier: $55/unit
- Factory overhead rate: 36% of Direct Labor
- The company has excess capacity (important for fixed overhead considerations)
Estimated Unit Costs to Produce Internally:
| Cost Element | Amount ($) |
|---|---|
| Direct Materials | $28.00 |
| Direct Labor | $16.00 |
| Factory Overhead | 36% of $16 = $5.76 |
| Total Cost | $49.76 |
Decision:
- Cost to Make: $49.76
- Cost to Buy: $55.00
Savings per Unit:
$55.00 (buy) – $49.76 (make) = $5.24/unit savings if the company makes the cases.
✅ Correct Answer: The company should make the carrying cases.
Explanation:
In a make-or-buy decision, management evaluates whether producing a good internally is more cost-effective than purchasing it externally. Pizana Computer Company currently buys carrying cases for its portable computers at $55 per unit. However, the company has spare production capacity, meaning it can take on additional production without incurring extra fixed overhead costs.
When considering making the cases in-house, the relevant costs include direct materials, direct labor, and variable overheads (applied here as factory overhead at 36% of direct labor). Based on the given data, the direct materials cost is $28.00, direct labor is $16.00, and factory overhead is $5.76 (36% of $16). Thus, the total cost to make one unit is $49.76.
Since this cost is lower than the purchase price of $55.00, the company would save $5.24 per unit by manufacturing the cases internally. Because there’s available capacity, these savings are meaningful and not offset by additional fixed costs (which would only be relevant if capacity needed to be increased).
In conclusion, producing the carrying cases in-house is the better financial decision. Not only does it reduce unit costs, but it also makes efficient use of idle resources. This is a classic example of using marginal cost analysis to enhance profitability in managerial decision-making.
