I need a discussion for week 6 for my Financial Managment and a resond to 2 classmates

JWI 530

The Mary Story

DECISION TIME – MAKE OR BUY?

DECISION TIME – MAKE OR BUY? We watched as Mary participated in a quarterly earnings call. She was anxious to put some of the information and strategies that she learned to work – and it wasn’t too long before she found the opportunity to do just that.

The new Perfume team was looking to take advantage of a short-term opportunity to make a small batch of special perfume in support of the upcoming World Cup event. After reviewing a memo from Mike, her operations manager, Mary learned that the assembly line required to make the perfume was already operating at full capacity.

Since Mike didn’t want to interrupt his normal production plan, he and the Purchasing Dept. identified a small supplier who was willing and able to take on the project and produce the new fragrance for ABC Perfume. Mary was excited…this would be a one-time effort, and she could certainly use the incremental profit the order represented!

Mike reminded Mary of the capacity challenge and pointed out that based on the P&L from Accounting for this product; his cost was $15.50 per oz. Since the 3rd party was willing to produce it for just $15.00 per oz., he explained that contracting with the smaller supplier was cheaper and avoided a conflict with his assembly plan.

This seemed reasonable to Mary, but then she remembered her discussion with Andrea about fixed and variable cost. She knew that the $15.50 was the total cost, including both fixed and variable cost. Further, she also knew that by definition, fixed costs would not change with changes in the number of units. Therefore, the actual cost of production would solely be based on the variable cost. She pulled out a separate report from Accounting and discovered that the variable cost of producing a similar product was just $10.00 per oz. If she compared the variable cost of producing to the supplier quote, then producing in-house would be much more cost effective

 

Mary paused for a moment and began to consider her options for this project. She recalled Andrea discussing the need to consider opportunity cost when at full capacity. She realized that producing this one new unit would reduce the number of the current units produced. Therefore, the lost profit (or really contribution) from selling fewer of the current unit needed to be considered. It was like a cost from “lost sales”.

She remembered that contribution was the difference between a unit’s variable revenue and its variable cost. Since the product sold for $40 per oz., it generated a ton of benefit…or contribution as Andrea called it. Therefore, she needed to recognize that not producing 1 oz. of the current perfume would “cost” her $30 per oz. in lost contribution.

If she added the variable cost and the opportunity cost, she came to a net cost of $40 per oz. if she chose to produce in-house. Comparing this to the supplier quote of $15 made this a “no-brainer”. Leveraging the outside supplier would be the best economic choice.

Mary picked up the phone to call Mike. He was going to be happy with her answer - even though she was going to have to explain all the ways his proposal was flawed!