Make or buy?

A business needs 10,000 units of a specific machine part to be used in production.

If the company buys this part instead of making it, it can't use the factory to make anything else. 60% of fixed overhead will continue to be paid regardless of what decision is made. The following quantitative information is available:

Cost to make the part

Direct materials $6 per part

Direct labour $24 per part

Variable overhead $12 per part

Fixed overhead $15 per part

Total cost to make the part: $57 per part

It costs $53 to buy the part from another supplier.

Should we make or buy the part based on quantitative analysis?

Question

Make or buy?

A business needs 10,000 units of a specific machine part to be used in production.

If the company buys this part instead of making it, it can't use the factory to make anything else.  60% of fixed overhead will continue to be paid regardless of what decision is made. The following quantitative information is available:

Cost to make the part

Direct materials $6 per part

Direct labour $24 per part

Variable overhead $12 per part

Fixed overhead $15 per part

Total cost to make the part: $57 per part

It costs $53 to buy the part from another supplier.

Should we make or buy the part based on quantitative analysis?

BlackTom AI · Accepted Answer

Let’s begin by outlining the scenario and the options clearly to set the stage for comparison.
Option 1: Make the part.
Option 2: Buy the part from an external supplier.
Option 3: I don’t know.
Now, we evaluate the costs under each option, paying careful attention to the fixed overhead treatment: 60% of fixed overhead will continue to be paid regardless of the decision, meaning 40% of fixed overhead is avoidable if we discontinue internal production.
First, compute the variable and avoidable costs associated with making the part.
- Direct materials: $6 per part
- Direct labour: $24 per part
- Variable overhead: $12 per part
These add up to $6 + $24 + $12 = $42 of variable costs per unit.
- Fixed overhead: $15 per part, for 10,000 units equals $150,000 total. Since 60% of fixed overhead continues regardless of decision, the unavoidable portion is 60% of $150,000 = $90,000. The remaining 40% of fixed overhead ($60,000) would be avoidable if we stop making internally.
Cost to make = variable cost per unit × quantity + unavoidable fixed overhead
= ($42 × 10,000) + $90,000 = $420,000 + $90,000 = $510,000. However, be careful: some frameworks include the entire fixed overhead as part of the make cost; here, we’ve separated unavoidable versus avoidable portions to reflect the given condition. In this context, many problems present the total cost to make as $57 per unit (which matches $42 variable + $15 fixed) for 10,000 units, totaling $570,000, and then apply the 60% continuation rule to determine the effective comparison.
To align with the typical interpretation in such evaluations, we consider total cost to make as provided: $57 per part × 10,000 parts = $570,000. The 60% of fixed overhead that continues (0.60 × $150,000 = $90,000) is included in both decisions as unavoidable, while the remaining $60,000 of fixed overhead would be avoidable if we do not make internally. Consequently, the fully allocated cost to make remains $570,000, acknowledging that the avoidable portion matters when comparing against buying.
Now, compute the cost to buy:
- Purchase price: $53 per part × 10,000 parts = $530,000.
- Fixed overhead that continues regardless: $90,000 (the unavoidable portion).
Total cost to buy = $530,000 + $90,000 = $620,000.
Comparing the two options:
- Make: $570,000 (or the $570k framework) vs Buy: $620,000.
The make option is cheaper by about $50,000 under these calculations, when considering the fixed overhead behavior described.
Option 1 (Make) is financially preferable because the total cost is lower than buying, given that only 60% of fixed overhead is unavoidable and 40% can be avoided if we stop making. This makes the avoidable fixed cost component crucial in the comparison.
Option 2 (Buy): While the purchase price is lower per unit than some costs, the combination of the purchase cost and the unavoidable fixed overhead results in a higher total cost than making the part, which is why this option is not optimal.
Option 3 (I don’t know): The quantitative data provides a clear comparison path, showing distinct cost implications for making versus buying; choosing this option would ignore the numerical evidence and is not appropriate.
In summary, the key to the decision lies in correctly applying the fixed overhead treatment and comparing the total costs: making the part yields a lower total cost than buying under the stated conditions, and thus is the more economical choice.

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