Question

Haver Company currently produces component RX5 for its sole product. The current cost per unit to manufacture the required 50,000 units of RX5 follows.

Direct materials . \( 5.00

Direct labor 8.00

Overhead . 9.00

Total cost per unit \)22.00

Check (1) Incremental cost

to make RX5, \(740,000

Direct materials and direct labor are 100% variable. Overhead is 80% fixed. An outside supplier has offered to supply the 50,000 units of RX5 for \)18.00 per unit.

Required

1. Determine whether the company should make or buy the RX5.

2. What factors besides cost must management consider when deciding whether to make or buy RX5?

Short answer

The total cost of making the product is $1,100,000.

Step-by-step solution

Definition of direct labor

Direct labor is the labor that is directly related to the production activities.

Calculation of total cost in make or buy

Particulars	Make	Buy
Direct Material	$250,000	$0
Direct Labor	$400,000	$0
Overhead	$450,000	$360,000
Offered Price	$0	$900,000
Total Cost	$1,100,000	$1,260,000

$\begin{array}{rcl}\mathbf{Direct}\mathbf{ }\mathbf{ }\mathbf{Material}\mathbf{ }\mathbf{ }\mathbf{Cost}& \mathbf{=}& \mathbf{ }\mathbf{ }\mathbf{No}\mathbf{.}\mathbf{ }\mathbf{of}\mathbf{ }\mathbf{units}\mathbf{\times }\mathbf{ }\mathbf{Cost}\mathbf{ }\mathbf{ }\mathbf{of}\mathbf{ }\mathbf{one}\mathbf{ }\mathbf{ }\mathbf{unit}\\ & \mathbf{=}& \mathbf{ }\mathbf{ }\mathbf{50}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{ }\mathbf{\$}\mathbf{5}\\ & \mathbf{=}& \mathbf{\$}\mathbf{250}\mathbf{,}\mathbf{000}\\ & & \end{array}$

The company should make the product because is less costly than buying the product from the supplier.

Other factors

The other factors management considers when deciding to make or buy RX5:

Timely supply of material required to produce the RX5.

Reputation of supplier who are supply the RX5.

Quality of product offered by the other supplier and quality produced by own.