STRUCTURING A MAKE-OR-BUY PROBLEM Fresh Foods, a large restaurant chain, needed to determine if it would be cheaper to produce 5,000 units of its main food ingredient for use in its restaurants or to purchase them from an outside supplier for $12 each. Cost information on internal production includes the following:

Total Cost Unit Cost Direct materials $25,000 $ 5.00 Direct labor 15,000 3.00 Variable manufacturing overhead 7,500 1.50 Variable marketing overhead 10,000 2.00 Fixed plant overhead 30,000 6.00 Total $87,500 $17.50 Fixed overhead will continue whether the ingredient is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price.

Required:

. What are the alternatives for Fresh Foods?

. List the relevant cost(s) of internal production and of external purchase.

. Which alternative is more cost effective and by how much?

. Now assume that 40 percent of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost effective and by how much?

Cornerstone Exercise