Question

Suppose Roasted Pepper restaurant is considering whether to (1) bake bread for its restaurant in-house or (2) buy the bread from a local bakery. The chef estimates that variable costs of making each loaf include \(0.52 of ingredients, \)0.27 of variable overhead (electricity to run the oven), and \(0.79 of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor, Roasted Pepper assigns \)0.96 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge $1.78 per loaf.

Requirements

1. What is the full product unit cost of making the bread in-house?

2. Should Roasted Pepper bake the bread in-house or buy from the local bakery? Why?

3. In addition to the financial analysis, what else should Roasted Pepper consider when making this decision?

Short answer

Answer

The full product unit cost of the bread is$2.54.

Step-by-step solution

Step-by-Step SolutionStep 1: Meaning of Variable Cost

The term variable cost refers to the cost that changes with each level of production. The variable cost directly relates to theproduction leveland enables the management to determine the price of a product.

Computation of full product unit cost

Particulars	Amounts ($)
Direct material	0.52
Direct labor	0.79
Variable overhead	0.27
Total variable cost per unit	1.58
Fixed overhead per leaf	0.96
Full product unit cost	$2.54

Decision on buy or make

As per the above calculations, the company should continue to make the product in-house because it will cost cheaper than buying it from the outside. The total variable cost per unit is $1.58, and the local bakery is offering the same at a price of $1.78, which is$0.20 higher.

Hence, the product should be made in-house.

Consideration of related factors

The Roasted Pepper should consider the following factors in addition to its financial analysis:

• The company must consider therequirement of the capacities for accepting such an offer from the local bakery.
• Thequality of the product served by the local bakery should also be considered by the company.
• Also, the company must ensure that if it buys the bread from the local bakery, then thedeliveries should be on time.