BMW Executive in Germany - Or1

Question:
Read and Answer the Required section:

Suppose a BMW executive in Germany is trying to decide whether the company should continue to
manufacture an engine component or purchase it from Mainz Corporation for 50 deutsche marks
(DM) each. Demand for the coming year is expected to be the same as for the current year, 200,000
units.
Data for the current year:
Direct material = DM 5,000,000
Direct labor = DM 1,900,000
Factory overhead, variable = DM 1,100,000 Factory overhead, fixed = DM 2,500,000
Total costs = DM 10,500,000
If BMW makes the components, the unit costs of direct materials will increase 10%. If BMW buys the
components, 40% of the fixed costs will be avoided. The other 60% will continue regardless of
whether the components are manufactured of purchased. Assume that variable overhead varies with
output volume.
Required: tabulate a comparison of the make-or-buy alternatives. Show totals and amounts per unit.
Compute the numerical difference between making and buying. Assume that the capacity now used
to make the components will become idle if the components are purchased. Would your evaluation
of the options change if BMW had the opportunity to rent the idle capacity to a manufacturing
company for DM 1,250,000 per year? How would it change?
Expert Answer
 Solution:
Part 1 – Statement of Comparison of Make or Buy alternatives

Statement of Comparison
Make Buy
Cost of Direct Material Per Unit 27.50
(5,000,000 / 200,000 Units *

110%)
Cost of Direct Labor per unit 9.50
(1,900,000 / 200,000 Units)
Variable Factory Overhead Per unit 5.50

(1,100,000 / 200,000 Units)
Purchase Price per unit 50.00
Total Per Unit Variable Cost 42.50 50.00
200,000
Total Expected Units 200,000 Units Units
Total Cost 8,500,000 10,000,000
Less: Saving in Fixed Overhead if Buy from

Outside supplier (2,500,000*40%) (1,000,000)
NET TOTAL COST UNDER EACH

ALTERNATIVE 8,500,000 9,000,000
Note –
1) Fixed Overheads --- If company make the product in house, the total fixed overhead are treated as Sunk
Cost. Since fixed overhead will remain same whether company make or not make the component. Hence it is
not considered in decision making whether to make or buy the product.
2) Since in case of buying the component from outside, 40% of Fixed Overhead can be avoided. It means there
is a saving in Fixed Overheads of 40% if company buy the component from outside. Hence it will reduce the
cost of the company.. Hence it is taken into consideration in case of buy the component from outside.
Part 2 ---
Cost of Making the Product In House = $8,500,000
Cost of Buying the product from outside = $9,000,000
Net Saving in making the product in house over the buying from outside = $500,000 (9000,000 – 8500,000)
In house making of component is more profitable than buying from outside. Company will save $500,000
(9000,000 – 8500,000) in making the component in house instead of buying from outside.
Part 3 – Statement of Comparison if company has idle capacity and BMW had the opportunity to rent the idle
capacity to a manufacturing company for DM 1,250,000 per year
Statement of Comparison
Make Buy
Total Cost for each alternative as calculated
in part 1 8,500,000 9,000,000
Less: Opportunity Cost (Rental Income

from idle capacity) if company buy product
from outside -1,250,000
NET COST 8,500,000 7,750,000

It is suggested to the company to buy the component from Outside since the Cost is lesser under Buy
alternative than the Make.
If company buy the component from outside, company is able to rent the idle capacity to other company at Dm
$1,250,000 which will become the income of company if they select to buy the component from outside.
Hence the Net Cost will be reduced by 1,250,000..
Company will save $750,000 (8,500,000 – 7,750,000) if they buy the component from outside..
Hope the above calculations, working and explanations are clear to you and help you in understanding the
concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the
doubt ASAP…thank you

BMW Executive in Germany - Or1

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Question:

Read and Answer the Required section:

Part 1 – Statement of Comparison of Make or Buy alternatives

Cost of Direct Material Per Unit 27.50

(5,000,000 / 200,000 Units *

Cost of Direct Labor per unit 9.50

(1,900,000 / 200,000 Units)

Variable Factory Overhead Per unit 5.50

Purchase Price per unit 50.00

Total Per Unit Variable Cost 42.50 50.00

Total Cost 8,500,000 10,000,000

Less: Saving in Fixed Overhead if Buy from

NET TOTAL COST UNDER EACH

Cost of Making the Product In House = $8,500,000

Cost of Buying the product from outside = $9,000,000

Less: Opportunity Cost (Rental Income

NET COST 8,500,000 7,750,000

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