- 20 Marks
MA – L2 – Q43 – Decision Making Techniques
Recommend whether to shut down internal production of Component A or B and switch to external purchasing based on cost analysis.
Question
Vento Industries makes two components, A and B, for which costs in the next year are expected to be as follows:
| A | B | |
|---|---|---|
| Production (units) | 30,000 | 20,000 |
| Variable costs per unit: | GH¢ | GH¢ |
| Direct materials | 6 | 5 |
| Direct labour | 3 | 9 |
| Variable production overheads | 1 | 3 |
| Variable production cost | 10 | 17 |
Direct labour is paid GH¢12 per hour. There will be only 19,500 hours of direct labour time available next year, and any additional components must be purchased from an external supplier.
Total fixed costs per annum are expected to be as follows:
| GH¢ | |
|---|---|
| Incurred as a direct consequence of making A | 40,000 |
| Incurred as a direct consequence of making B | 50,000 |
| Other fixed costs | 30,000 |
| 120,000 |
An external supplier has offered to supply units of A for GH¢12.50 and units of B for GH¢23.
Required:
(a) Recommend whether Vento Industries should shut down internal production of Component A or Component B and switch to external purchasing.
(b) Recommend the quantities that Vento Industries should make of the components, and the quantities that it should buy externally, in order to obtain the required quantities of both components at the minimum cost. Calculate what the total annual cost will be.
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