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 solve a Make-or-Buy Decision, we must compare the cost of making the product internally with the purchase price from an external supplier. Let’s first assume you meant the internal cost breakdown is provided as below (a common format for such problems):
Expected Unit Costs to Produce Carrying Case:
- Direct Materials: \$30
- Direct Labor: \$20
- Factory Overhead: 36% of Direct Labor = 0.36 × \$20 = \$7.20
Total Cost to Make Internally:
= Direct Materials + Direct Labor + Factory Overhead
= \$30 + \$20 + \$7.20
= \$57.20 per unit
Purchase Cost from Supplier:
= \$55 per unit
Decision:
- Make Cost = \$57.20
- Buy Cost = \$55
Since \$57.20 > \$55, the company should buy the carrying cases from the supplier.
300-Word Explanation:
The make-or-buy decision is a key managerial accounting choice that organizations make when determining whether to manufacture a product component internally or to purchase it from an outside supplier. In this scenario, Pizana Computer Company is assessing whether it should continue buying carrying cases at \$55 per unit or begin manufacturing them in-house.
To make this decision, we analyze the internal costs: direct materials, direct labor, and factory overhead. Direct materials cost \$30 and direct labor is \$20. Factory overhead is applied at 36% of the direct labor cost, equating to \$7.20. Therefore, the total internal production cost per unit is \$57.20.
Comparing this with the external purchase cost of \$55, buying the cases is more cost-effective, saving the company \$2.20 per unit.
It’s also important to note the company is operating below full capacity. In such a case, if there’s idle capacity that could be used without incurring additional fixed costs, managers might consider making the product despite the slightly higher cost, especially if doing so offers strategic benefits like quality control or flexibility. However, from a purely financial standpoint and assuming no opportunity costs or qualitative advantages, buying the cases is the better decision.
This example highlights the importance of considering only relevant costs—costs that differ between alternatives. Here, the relevant costs are the variable costs of making the product and the cost of buying. Fixed overhead costs unrelated to this decision should be ignored.