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Homework answers / question archive / A company manufactures telephones
A company manufactures telephones. The company is currently operating at full capacity and variable manufacturing costs are charged to produce at the rate of 25% of direct labour cost.
Consider the following information:
Direct Materials cost per unit equals to 30€
Direct Labour cost per unit equals to 10€
Normal Production is 50.000 units per year
The 30.000€ of Fixed Manufacturing Overheads cannot be eliminated in case the production stops and will have to be absorbed by other products.
A supplier offers to make the telephones at a price of 40€ each. Should the company buy the telephones from the outside supplier?
The decision to be made is an outsourcing decision often called as 'make or buy' decision. Following table represents savings/benefits of outsourcing the telephone:
| Particulars | Notes | Amounts |
| Savings in direct material costs | 1 | 30 |
| Add: Savings in direct labour costs | 1 | 10 |
|
Add: Savings in variance manufacturing costs (25% of Direct labour costs) |
1 | 2.5 |
| Add: Savings in fixed manufacturing costs | 2 | 0 |
| Less: Purchase price of telephone | 3 | -40 |
|
Net effect of outsourcing decision (I.e. Savings per unit in the given case) |
2.5 |
Notes:
Hence, the company should buy the telephone from supplier as it results in savings of €2.5 per unit of telephone.
