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Make or Buy Decisions

ACCA · Question 24 · Make or Buy Decisions

Section B - Case 2: BioNutri

BioNutri manufactures two specialized nutritional supplements: Alpha and Beta. Both products require processing on a specialized mixing machine. The machine is available for a maximum of 1,200 hours per month.

Product details:
Alpha: Selling price $50, Variable cost $30, Machine hours per unit: 2 hours. Maximum demand: 400 units.
Beta: Selling price $70, Variable cost $40, Machine hours per unit: 4 hours. Maximum demand: 300 units.

An external supplier has offered to manufacture Product Alpha for BioNutri at a price of $38 per unit. Assuming machine hours remain limited to 1,200, should BioNutri make or buy Product Alpha?

Answer options:

A.

Make, because the variable cost to make ($30) is lower than the purchase price ($38).

B.

Make, because buying it would reduce the overall contribution of the company.

C.

Buy, because the relevant cost of making Alpha is $45, which is higher than the purchase price of $38.

D.

Buy, because the supplier's price of $38 is lower than the selling price of $50.

How to approach this question

Calculate the relevant cost to make: Variable Cost + Opportunity Cost. Opportunity cost is the contribution lost by not making the next best alternative (Beta) with those 2 hours.

Full Answer

C.Buy, because the relevant cost of making Alpha is $45, which is higher than the purchase price of $38.✓ Correct
Because machine hours are limited, making Alpha incurs an opportunity cost. Every unit of Alpha takes 2 hours. If those 2 hours were freed up, they would be used to make Beta (which earns $7.50 per hour). Opportunity cost = 2 hours × $7.50 = $15. Relevant cost to make Alpha = Variable cost ($30) + Opportunity cost ($15) = $45. Since the purchase price ($38) is less than the relevant cost to make ($45), BioNutri should buy Alpha.

Common mistakes

Comparing only the variable cost ($30) to the purchase price ($38) and concluding they should make it, completely ignoring the limiting factor.
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