Swanson Company currently buys 30,000 units of a part used to manufacture its product at $40 per unit. Recently the supplier informed Swanson that a 20 percent increase will take effect next year. Swanson has some additional space and required facilities and could produce the units for the following per-unit costs (based on 30,000 units):
Direct materials $16
Direct labour 12
Variable overhead 12
Fixed overhead 10
If the units are purchased from the supplier, $200,000 of fixed costs will continue to be incurred. In addition, the facilities can be rented out for $20,000 per year if the parts are purchased externally.
Required:
Should Swanson Company buy the part externally or make it internally? Explain with detailed calculations.
Introduction
In the competitive landscape of business, decisions related to sourcing components can have a significant impact on a company’s cost structure and overall profitability. The decision to make or buy a component involves evaluating whether it is more economical to manufacture the part internally or purchase it from an external supplier. In the case of Swanson Company, the decision of whether to continue purchasing a part externally or start producing it internally requires a comprehensive analysis of various cost factors and financial implications.
Cost Comparison
To determine the most cost-effective approach, we need to compare the costs associated with both options: buying the part externally and making it internally.
External Purchase
Currently, Swanson Company purchases 30,000 units of the part at $40 per unit, resulting in an annual cost of: Cost per unit * Units = $40 * 30,000 = $1,200,000
The supplier has informed about a 20% price increase, which would lead to a new cost of: New cost per unit = $40 * 1.20 = $48
New annual cost = New cost per unit * Units = $48 * 30,000 = $1,440,000
Additionally, there are fixed costs associated with purchasing externally: Fixed costs = $200,000
Facility rental income if purchased externally = $20,000
Total external cost = New annual cost + Fixed costs – Facility rental income Total external cost = $1,440,000 + $200,000 – $20,000 = $1,620,000
Internal Production
If Swanson Company decides to produce the part internally, it incurs various costs related to direct materials, direct labor, variable overhead, and fixed overhead.
Cost per unit for internal production = Direct materials + Direct labor + Variable overhead + Fixed overhead Cost per unit for internal production = $16 + $12 + $12 + $10 = $50
Total cost for internal production = Cost per unit for internal production * Units Total cost for internal production = $50 * 30,000 = $1,500,000
Analysis and Decision
Comparing the total costs of both options, we find that:
Total external cost: $1,620,000
Total internal cost: $1,500,000
Based on the analysis, it is evident that producing the part internally is more cost-effective for Swanson Company. The internal production cost of $1,500,000 is lower than the external purchasing cost of $1,620,000. This decision results in a cost savings of $120,000.
Conclusion
In conclusion, Swanson Company should opt for internal production of the part rather than purchasing it externally. The comprehensive cost analysis clearly demonstrates that internal production offers a cost advantage, enabling the company to save $120,000 annually. However, it is important to consider other factors such as quality control, production capacity, and potential risks when making this decision. By making an informed choice, Swanson Company can optimize its cost structure and enhance its overall profitability in the dynamic business environment.
As a renowned provider of the best writing services, we have selected unique features which we offer to our customers as their guarantees that will make your user experience stress-free.
Unlike other companies, our money-back guarantee ensures the safety of our customers' money. For whatever reason, the customer may request a refund; our support team assesses the ground on which the refund is requested and processes it instantly. However, our customers are lucky as they have the least chances to experience this as we are always prepared to serve you with the best.
Plagiarism is the worst academic offense that is highly punishable by all educational institutions. It's for this reason that Peachy Tutors does not condone any plagiarism. We use advanced plagiarism detection software that ensures there are no chances of similarity on your papers.
Sometimes your professor may be a little bit stubborn and needs some changes made on your paper, or you might need some customization done. All at your service, we will work on your revision till you are satisfied with the quality of work. All for Free!
We take our client's confidentiality as our highest priority; thus, we never share our client's information with third parties. Our company uses the standard encryption technology to store data and only uses trusted payment gateways.
Anytime you order your paper with us, be assured of the paper quality. Our tutors are highly skilled in researching and writing quality content that is relevant to the paper instructions and presented professionally. This makes us the best in the industry as our tutors can handle any type of paper despite its complexity.
Recent Comments