Fancy phone covers makes and sells phone covers. They sell 200 covers for $20 each. To make one cover costs $2 in direct materials, $3 in direct labour, $1 for plastic wrap packaging and fixed costs of $600.

Another business has offered to sell Fancy phone covers 200 of the exact same covers for $7 each. If Fancy buys the covers then they won't need to pay $550 of the fixed costs.

When making this make or buy decision, what is the relevant cost to make the covers per cover?

Round your answer to two decimal places.

Question

Fancy phone covers makes and sells phone covers. They sell 200 covers for $20 each. To make one cover costs $2 in direct materials, $3 in direct labour, $1 for plastic wrap packaging and fixed costs of $600.

Another business has offered to sell Fancy phone covers 200 of the exact same covers for $7 each. If Fancy buys the covers then they won't need to pay $550 of the fixed costs.

When making this make or buy decision, what is the relevant cost to make the covers per cover?

Round your answer to two decimal places.

BlackTom AI · Accepted Answer

Let's restate the scenario and identify the costs involved in the make versus buy decision.
- We are considering making or buying 200 covers.
- If Fancy makes the covers: direct materials = 2, direct labour = 3, plastic wrap packaging = 1, and fixed costs = 600 in total.
- If Fancy buys the covers: they would not pay 550 of the fixed costs (i.e., 550 would be avoided), so the fixed cost burden would be 600 - 550 = 50 when buying.
- The purchase price from the external supplier is 7 per cover.

Now, determine the relevant costs for the decision. Relevant costs are those that will be different between making and buying decisions; that is, costs that can be avoided or incurred as a result of choosing one option over the other.

Option 1: Cost to make per cover (relevant costs per unit)
- Direct materials: 2 (relevant, since this is a variable cost tied to producing each unit)
- Direct labour: 3 (relevant, per unit)
- Plastic wrap packaging: 1 (relevant, per unit)
- Fixed costs: not all fixed costs are avoidable. Here, 550 of the fixed costs would be avoided if we buy, leaving 50 fixed costs that would still be incurred regardless of the decision. The portion of fixed costs that varies with the decision is the portion that would be saved by buying, i.e., 550 total across 200 units, which is 550/200 = 2.75 per unit. This 2.75 per unit is a relevant cost because it would not be incurred if we chose to buy.
- Therefore, the relevant cost to make per cover is: 2 + 3 + 1 + 2.75 = 8.75.

Option 2: Cost to buy per cover (for comparison, though the question asks for make’s relevant cost)
- Purchase price per cover: 7
- Fixed costs that remain (the 50 that would still be paid if buying): 50 total fixed costs across 200 units, or 50/200 = 0.25 per unit. This 0.25 per unit is a sunk consideration for the make choice since it would be paid regardless of producing or buying in the buy scenario, but for completeness it would contribute to the per-unit cost if you were tallying total costs under the buy option.
- Total relevant cost of buying per cover would be 7 + 0.25 = 7.25 per cover if you were constructing a full per-unit cost, but the problem asks specifically for the relevant cost to make, so focus remains on the make side.

Key conceptual check: This problem aims to compare the make cost to the buy cost by considering variable costs (2 + 3 + 1 = 6) plus the portion of fixed costs that would be avoided by buying (550 total across 200 units, i.e., 2.75 per unit). This yields 8.75 per cover as the relevant make cost per unit.

Summary of the core reasoning: The per-cover relevant cost to make includes all variable costs (6) plus the portion of fixed costs that would be avoided if the decision is to buy (2.75), totaling 8.75 per cover. The result is not just the pure variable cost (6) because the fixed-cost savings are a key part of the decision in a make-or-buy scenario. The remaining fixed costs that cannot be avoided (50 total, or 0.25 per unit) do not alter the make-relevant-cost calculation, since they are not saved by buying in the context of the question's focus on the make cost per unit. Therefore, the carefully reasoned make cost per cover is 8.75.

BACC011 Week 11: Practice Quiz

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