A company manufactures a component at a variable cost of ₹40 per unit and incurs a fixed cost of ₹2,00,000 per year. An outside supplier offers the same component at ₹60 per unit. What should the company do if the annual demand is 12,000 units?
Continue manufacturing the component in-house as it is more cost-effective
Make-vs-Buy analysis: To decide whether to manufacture a component in-house ("make") or purchase it from an outside supplier ("buy"), we compare the total annual cost of each option at the given demand. The make option carries a fixed cost (which is incurred regardless of volume) plus a per-unit variable cost, whereas the buy option is purely a per-unit purchase price.
Step 1 — Cost of making in-house:
- Variable cost = ₹40 × 12,000 = ₹4,80,000
- Fixed cost = ₹2,00,000
- Total make cost = ₹4,80,000 + ₹2,00,000 = ₹6,80,000 per year
Step 2 — Cost of buying (outsourcing):
- Total buy cost = ₹60 × 12,000 = ₹7,20,000 per year
Step 3 — Compare: Make cost ₹6,80,000 < Buy cost ₹7,20,000. Making in-house is cheaper by ₹7,20,000 − ₹6,80,000 = ₹40,000 per year. Therefore the company should continue manufacturing the component in-house.
Break-even check (why demand matters): Making becomes cheaper only when its lower variable cost recovers the fixed cost. Break-even quantity = Fixed cost ÷ (Buy price − Variable cost) = 2,00,000 ÷ (60 − 40) = 10,000 units. Since actual demand (12,000) exceeds 10,000 units, in-house manufacture is justified — confirming the calculation.
Why the other options are wrong:
- Outsource to the supplier is incorrect because buying costs ₹40,000 more per year at this volume.
- Split production equally and reduce production and buy the rest both mix in the higher-priced ₹60 units, so any units bought above the break-even volume only raise total cost — there is no advantage in outsourcing part of a demand that is already above break-even.
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