Hahn Manufacturing purchases a key component of
one of its products from a local supplier. The current
purchase price is $1,500 per unit. Efforts to standardize
parts succeeded to the point that this same component
can now be used in five different products. Annual com-
ponent usage should increase from 150 to 750 units.
Management wonders whether it is time to make the
component in-house, rather than to continue buying it
from the supplier. Fixed costs would increase by about
$40,000 per year for the new equipment and tooling
needed. The cost of raw materials and variable overhead
would be about $1,100 per unit, and labor costs would be
$300 per unit produced.
a. Should Hahn make rather than buy?
b. What is the break-even quantity?
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Should Hahn make rather than buy?
To determine whether Hahn Manufacturing should make the component in-house or continue buying it from the supplier, we need to compare the costs of both options.
a. To make the component in-house:
- Fixed costs: $40,000 per year
- Variable costs: $1,100 per unit for raw materials and variable overhead, plus $300 per unit for labor costs
b. To buy the component from the supplier:
- Purchase price: $1,500 per unit
To determine the break-even quantity, we need to find the point at which the costs of making the component in-house equal the costs of buying it from the supplier.
Let's calculate the costs for each option based on the given information:
Cost of making the component in-house:
Total variable cost per unit = $1,100 (raw materials and variable overhead) + $300 (labor costs) = $1,400
Total cost per unit = Total variable cost per unit + Fixed costs per year / Annual component usage
Total cost per unit = $1,400 + $40,000 / 750 = $54.67
Cost of buying the component from the supplier:
Total cost per unit = Purchase price per unit = $1,500
Now, let's compare the costs:
If the total cost per unit of making the component in-house ($54.67) is lower than the purchase price per unit ($1,500), then Hahn should make the component in-house.
If the total cost per unit of making the component in-house is higher than the purchase price per unit, then Hahn should continue buying it from the supplier.
Therefore, in this case, Hahn should continue buying the component from the supplier as the purchase price per unit is lower than the total cost per unit of making it in-house.
To calculate the break-even quantity, we need to find the point at which the total cost of making the component in-house equals the total cost of buying it from the supplier.
Let's set up the equation:
Total cost of making in-house = Total cost of buying
($1,400 + $40,000 / x) = $1,500
$1,400 + $40,000 / x = $1,500
$40,000 / x = $1,500 - $1,400
$40,000 / x = $100
$40,000 = $100x
x = $40,000 / $100
x = 400
The break-even quantity is 400 units.
To determine whether Hahn Manufacturing should make or buy the component, we need to compare the costs of making the component in-house with the current purchase price.
a. To calculate the cost of making the component in-house, we need to add the fixed costs (new equipment and tooling) and the variable costs (raw materials, variable overhead, and labor costs) per unit.
Total cost per unit = Fixed costs + Variable costs per unit
Fixed costs = $40,000 per year
Variable costs per unit = Cost of raw materials + Variable overhead + Labor costs per unit
Cost of raw materials = $1,100 per unit
Variable overhead = $0 (not given)
Labor costs per unit produced = $300 per unit
Variable costs per unit = $1,100 + $0 + $300 = $1,400
Total cost per unit = $40,000 + $1,400 = $41,400
Therefore, the cost of making the component in-house would be $41,400 per unit.
To determine whether Hahn should make or buy, we need to compare this cost with the current purchase price of $1,500 per unit.
If the cost of making is higher than the purchase price, it would be more cost-effective to continue buying. If the cost of making is lower, it would be more beneficial to make the component in-house.
In this case:
Cost of making = $41,400 per unit
Purchase price = $1,500 per unit
Since the cost of making is significantly higher than the purchase price, Hahn Manufacturing should not produce the component in-house but continue buying it from the supplier.
b. The break-even quantity refers to the quantity at which the cost of making and the purchase price are equal. To calculate the break-even quantity, we need to set the cost of making equal to the purchase price and solve for the quantity.
Cost of making per unit = Purchase price per unit
$41,400 per unit = $1,500 per unit
Dividing both sides of the equation by $1,500 gives:
Quantity = $41,400 / $1,500
Quantity = 27.6
The break-even quantity is approximately 27.6 units. In this case, it means that Hahn Manufacturing would need to produce and sell at least 28 units of the component for making it in-house to become cost-effective compared to buying it from the supplier.