Structuring a Make-or-Buy Problem

Fresh Foods, a large restaurant chain, needs 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 CostUnit CostDirect materials$25,000$5.00Direct labor15,0003.00Variable manufacturing overhead7,5001.50Variable marketing overhead10,0002.00Fixed plant overhead30,0006.00Total$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. If required, round your answers to the nearest whole number.

Required:

1.What are the alternatives for Fresh Foods?

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

3.Which alternative is more cost effective and by how much? (Use total cost when giving your answer.)

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4.Now assume that 20% of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost effective and by how much? (Use total cost when giving your answer.)

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