Question Tag: Make or buy decision

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  • 20 Marks

MA – Mar 2024 – L2 – Q5 – Relevant cost and revenue | Decision making techniques

This question determines the optimal units for in-house production versus outsourcing based on machine hour constraints and relevant cost analysis.

Hwerema Technologies produces various components for telecom companies. The demand for these components is increasing. However, Hwerema Technologies’ production facility is restricted to 50,000 machine hours. Therefore, the company is considering whether to import certain components to make up for the shortfall in production to meet market demand. In this respect, the following information has been gathered:

Factory overheads include fixed overheads estimated at GH¢1.50 per machine hour.

Required:
a) Determine the optimal units to be produced in-house and units to be imported. (16 marks)
b) State FOUR (4) qualitative considerations relevant to make-or-buy decisions. (4 marks)

a) Optimal decision

b)

Non-financial considerations relevant to make or buy decisions

Risk of outsourcing works:

  • Suppliers may produce items to a lower standard of quality.
  • The supplier may fail to meet delivery date and the buyer may depend on the
    supplier to commit onward delivery to its buyer. In case of buying of a component,
    production process of the end-product may be held up by a lack of component.

Benefits of outsourcing work:

  •  Outsourcing work will enable the management to focus all its efforts on those
    aspects of operation the entity does best.
  • The external supplier may have specialist expertise which enables it to provide
    outsourced products more efficiently and at a cheaper price.
  • 20 Marks

MA – May 2021 – L2 – Q5b – Decision making techniques, Budgetary control

Recommend the quantities Agrow Ltd should produce in-house and purchase externally, along with the total annual cost.

Agrow Ltd is a community company that manufactures and sells car components; Wiper, Driving mirror, and Brake pad. The budgeted information for the next year is expected to be as follows:

WIPERS DRIVING MIRROR BRAKE PAD
Production (units) 50,000 25,000 35,000
GH¢ GH¢ GH¢ GH¢
Selling price per unit 34 30 28
Direct material per unit 9 10 5
Direct labour cost per unit 18 3 12
Variable production overhead 1 2 1

Direct labour is paid at GH¢12 per hour. While other production factors are unlimited, labour is limited to 102,500 hours. Hence, an extra component must be purchased from an external supplier.

Total fixed cost per annum is expected to be as follows:

Cost GH¢
Incurred as a direct consequence of making any quantity of Wiper 140,000
Incurred as a direct consequence of making any quantity of Driving mirror 255,000
Incurred as a direct consequence of making any quantity of Brake pad 150,000
Other Fixed Cost 60,000
Total Fixed Cost 605,000

An external supplier has offered to supply a unit of the following at their respective prices:

Component GH¢
Wiper 32
Driving mirror 24
Brake pad 23

Required:

a) Advise which of the products Agrow Ltd should make in-house or outsource. (7 marks)

b) Recommend the quantities that Agrow Ltd should make and the quantities it should buy externally to obtain the required quantities of all the parts and calculate the total annual cost. (10 marks)

c) State THREE (3) factors to consider before setting a selling price of a product. (3 marks)

(Total: 20 marks)

a) Make or Buy Decision for Agrow Ltd

Component Wiper Driving Mirror Brake Pad
Marginal cost per unit (GH¢) 28 15 18
Demand (units) 50,000 25,000 35,000
Total variable cost 1,400,000 375,000 630,000
Cost incurred as a direct consequence of making 140,000 255,000 150,000
Total cost of making the product 1,540,000 630,000 780,000
Cost of buying:
50,000 x GH¢32 1,600,000
25,000 x GH¢24 600,000
35,000 x GH¢23 805,000
Cost saving / (extra) for making the product 60,000 (30,000) 25,000

Decision:

  • Wiper: Make in-house (as the cost saving is GH¢60,000).
  • Driving Mirror: Buy externally (as buying saves GH¢30,000).
  • Brake Pad: Make in-house (as the cost saving is GH¢25,000).

(7 marks)

b) Production and Purchase Plan for Agrow Ltd

Product Quantity Contribution per unit Labour hour per unit Contribution per labour hour Rank
Wiper 50,000 GH¢6 1.5 GH¢4 2nd
Brake Pad 35,000 GH¢10 1 GH¢10 1st

Production Plan:

Product Quantity to Make Labour Hours Hours Available
Brake Pad 35,000 35,000
Wiper 45,000 67,500
Total Hours 102,500

Buying Plan:

  • Wiper: Buy 5,000 units.
  • Driving Mirror: Buy 25,000 units.

Total Annual Cost:

Product Quantity Cost per unit (GH¢) Total Cost (GH¢)
Brake Pad (make) 35,000 18 630,000
Wiper (make) 45,000 28 1,260,000
Wiper (buy) 5,000 32 160,000
Driving Mirror (buy) 25,000 24 600,000
Direct consequence of making Wiper – – 140,000
Direct consequence of making Brake Pad – – 150,000
Other Fixed Cost – – 60,000
Total Cost 3,000,000

(10 marks)

c) Factors to Consider in Setting a Selling Price

  1. Cost of production: Ensures that the selling price covers all costs and yields a profit.
  2. Price of competing firms: Helps to position the product competitively in the market.
  3. Purchasing power of customers: Ensures the price is aligned with what customers can afford.

(3 marks)

Total Marks for Question 5: 20 marks

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