Make or buy decision

The management of Springer plc is considering next year's production and purchase budgets.

One of the components produced by the company, which is incorporated into another All product before being sold, has a budgeted manufacturing cost as follows:

Â	(£)
Direct material	14
Direct labour (4 hours at £3 per hour)	12
Variable overhead (4 hours at £2 per hour)	8
Fixed overhead (4 hours at £5 per hour)	20
Total cost	54 per unit

Trigger plc has offered to supply the above component at a guaranteed price of £50 per unit.

Required:

(a) Considering cost criteria only, advise management whether the above component should be purchased from Trigger plc. Any calculations should be shown and assumptions made, or aspects which may require further investigation should be clearly stated.

(b) Explain how your above advice would be affected by each of the two separate situations shown below.

(i) As a result of recent government legislation if Springer plc continues to manufacture this component the company will incur additional inspection and testing expenses of £56 000 per annum, which are not included in the above budgeted manufacturing costs.

(ii) Additional labour cannot be recruited and if the above component is not manufactured by Springer plc the direct labour released will be employed- in increasing the production of an existing product which is sold for £90 and which has a budgeted manufacturing cost as follows:

Direct material	10
Direct labour	24
(8 hours at £3 per hour)	Â
Variable overhead	16
(8 hours at £2 per hour)	Â
Fixed overhead	Â
(8 hours at £5 per hour)	40
Â	90 per unit

All calculations should be shown.

(c)The production director of Springer plc recently said:

‘We must continue to manufacture the component as only one year ago we purchased some special grinding equipment to be used exclusively by this component. The equipment cost £100 000, it cannot be resold or used elsewhere and if we cease production of this component we will have to write off the written down book value which is £80 000.’

Draft a brief reply to the production director commenting on his statement.