Step 1: Calculate the total annual cost of buying (outsourcing).
This is the cost if all 50,000 units are purchased from the supplier.
- Formula: Cost to Buy = Annual Demand × Price per unit
- Calculation: 50,000 units × $12/unit = $600,000
Step 2: Calculate the total annual cost of making in-house.
This is the sum of the variable and fixed costs for producing 50,000 units internally.
- Formula: Cost to Make = (Variable Cost per unit × Annual Demand) + Fixed Costs
- Calculation: ($8/unit × 50,000 units) + $250,000
- Calculation: 400,000+250,000 = **650,000∗∗
Step 3: Compare costs and provide a quantitative recommendation.
- Total Cost to Buy: 600,000
- Total Cost to Make: 650,000
- Comparison: The cost to buy is $50,000 less than the cost to make for an annual demand of 50,000 units.
- Recommendation: Based purely on financial grounds, AeroComponents should buy the bolts from the external supplier.
Step 4: Further Analysis (Break-Even Point).
To find the output level where the decision changes, we calculate the break-even quantity.
- Formula: Break-Even Quantity = Fixed Costs / (Price to Buy - Variable Cost to Make)
- Calculation: 250,000/(12 - 8)=250,000 / $4 = 62,500 units.
- Interpretation: If annual demand were to rise above 62,500 units, making the bolts in-house would become the cheaper option. Since current demand (50,000) is below this break-even point, buying remains the more cost-effective choice.
Step 5: Qualitative Evaluation.
While buying is cheaper, AeroComponents must also consider qualitative factors. For aircraft-grade bolts, quality and reliability are paramount. In-house production offers greater control over quality assurance and production schedules. The final decision involves a trade-off between the lower cost of outsourcing and the greater control offered by in-house production.