Suppose an Olive Terrace 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 $0.48 of ingredients, $0.23 of variable overhead (electricity to run the oven), and $0.72 of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor assigns $1.04 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge Olive Terrace $1.74 per loaf.

1. What is the absorption cost of making the bread in-house? What is the variable cost per loaf?

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

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