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MAKE and BUY DECISION

Presented By :
Ankita Sharma MBA/10048/18
Neha Kumari MBA/10025/18
Niket Kumar MBA/10074/18
Introduction
• The make-or-buy decision is the act of making
a strategic choice between producing an item
internally (in-house) or buying it externally
(from an outside supplier). The buy side of the
decision also is referred to as outsourcing.
Example :1
• Furniture Inn manufactures computer tables. Recently a supplier has offered the tables of the same quality
@ $14 each with an assurance of continued supply. The following is the budget for 4000 units prepared for
the quarter ending 30 September 2016:

Required:
• (a) Should Furniture Inn accept the offer from the supplier?
• (b) What would be the decision if the supplier offered the tables at $12 each?
Solution :  Calculation of per table marginal cost of production

• (a) As marginal cost of production is less than the buying price offered by the supplier so Furniture
Inn should continue production of tables. The distribution, administration and fixed production are
irrelevant in the decision as presumptively they will be incurred in either case.
• (b) As in this case they buy in price $12 is less than the marginal cost of production so Furniture Inn
should buy the tables from the supplier and discontinue production of tables provided other things
are favorable.
EXAMPLE
• The estimated costs of producing 6,000 units of a component are:

Per unit Total


Direct Material $10 $60000
Direct Labor 8 48000
Applied Variable 9 54000
Factory Overhead
Applied Fixed 12 72000
Factory
Overhead$1.5 per
direct labor dollar
$39 $234000

• The same component can be purchased from market at a price of $29 per unit. If the component is
purchased from market, 25% of the fixed factory overhead will be saved.
• Should the component be purchased from the market?
• Solution:
Make Buy Make Buy
Purchase $ 29 $174000
Price
Direct $10 $60000
Material
Direct 8 48000
Labor
Variable 9 54000
Overhead
Relevant 3 18000
Fixed
Overhead
Total $30 $29 $180000 $174000
Relevant
Costs

The company should take buying decision in this case.


Make or Buy Decision
Example 2

Product X takes 20 hrs on machine 99. It has a selling price of rs.


100 and marginal cost of rs. 60. Y could be made on machine 99
in 3 hrs for a marginal cost of rs. 5. the supplier’s price is rs. 10.
Should one make or buy Y? Discuss the both situation
i. When machine 99 is working at full capcity and
ii. When there is idle capacity.

What are the other non-cost considerations to kept in the mind


is such case?
Example 2

Solution:

i. When machine 99 is working at full capacity:

In this situation, cost of the component Y plus contribution lost during the period of
manufacturing should be compare with supplier’s price.
Selling price of X= 100
Less: Marginal Cost 60
Contribution 40
Contribution per hrs= Rs 40 ÷ @0 hrs = Rs 2
Cost of making Y = Marginal cost + Contribution lost
= Rs 5 + Rs 6 (3hrs @Rs. 2per hrs)
= Rs 11
Cost of Y if bought = Rs 10
As the cost of making is more than suppliers price, it is advisable to buy it.
Example 2

Solution:

ii. When machine 99 has idle capacity:


In this situation, there will be no loss of contribution when component Y is made
because machine will be idle during that period if Y is not made. The cost of making
will be only its marginal cost of Rs 5. As the supplier’s price is Rs10, it is advisable to
make this component Y.

Non-cost Consideration
1. Assurance of continued supply, if bought from outside
2. Adherence to delivery schedule
3. Assurance of reliable quality
4. Assurance of no price change during the period of agreement
Make or Buy Decision
Example 3
Stirling Industries LTD manufactures a product ‘Z’ by making and assembling thee component A,B
and C. The component are made in a machine shop using three identical machines each of which
can make any of the three components. However the total capacity of the three machines is only
RS. 12,000 machine-hours per month and is just sufficient to meet the current demand. Labor for
assembling is available according to requirements. Further details are given below:

Fixed cost per month to Rs 50,000. Product ‘Z’ is sold at Rs 300 per unit.
From next month onwards, the company expects the demand for ‘Z’ to rise by 25%. As the
machine capacity is limited, the company wants to meet the increase in demand by buying such
numbers of A,B or C is most profitable.

Components Machine-hours required per unit Variable cost per unit Market price at which the component can be
purchased if required Rs.

A 4 48 64
B 5 60 75
C 6 80 110
Assembling - 30(per unit of Z) -
Make or Buy Decision
Example 3

Find Out
1. Current demand and profit made by the company
2. Which component and how many units of the same, should be bought
from the market to meet the increase in demand?
3. Profit, made by the company, if suggestion in (2.) is accepted.
Make or Buy Decision
Example 3

Solution:

1. Man-hours required per unit of Z= 4+5+6 = 15


No. of units of Z to be made in 12000 hrs = 12000 ÷ 15 = 800
Variable cost per unit = RS 48 + 60 + 30 = RS 218
Contribution per unit = SP – VC = RS 300 –RS 218 =RS 82
Total contribution ( 800 * 82) 65,600
Less:- Fixed cost 50,000
Current Profit 15,600
Make or Buy Decision
Example 3
Solution:
2. Addition cost per hour, if component is purchased from market

Component A B C

Market price per unit Rs. 64 75 110

Less: Variable cost of making Rs. 48 60 80

i. Extra cost, if purchased Rs. 16 15 30

ii. No. extra hrs per unit 4 5 6

Component B has thecost


Adding latest
per addition
hrs ÷ (ii) cost per hrs.
4 Therefore, it is best
3 to purchase B component.
5
For next month demand is=800 units + 25%= 1000units
Hours required for 1000 units of Z
Component C(1000 * 6 hrs) 6000
A(1000 * 4hrs) 4000
B Balance (400 *5hrs) 2000
Total 12000
Make or Buy Decision
Example 3
Solution:
3. Computation of profit as per ‘b’ above
Rs.
Sales(1000 units * Rs 300) 3,00,000
Variable cost of component C (1000 units @Rs.80) 80000
A (1000 units @Rs.48) 48000 B (400 units @ Rs. 60)
24000
Cost of buying B (600 units @ Rs.75) 45000
Cost of assembling (1000 units @ Rs. 30) 30000
Total variable cost 227000
Contribution (Sales-variable cost) 73000
Less: Fixed cost 50000
Profit 23000