A company is considering the possibility of purchasing from a supplier a component it now makes. The supplier will provide the components in the necessary quantities at a unit price of £9. Transportation and storage costs would be negligible.
The company produces the component from a single raw material in economic lots of 2000 units at a cost of £2 per unit. Average annual demand is 20 000 units. The annual holding cost is £0.25 per unit and the minimum stock level is set at 400 units. Direct labour costs for the component are £6 per unit, fixed manufacturing overhead is charged at a rate of £3 per unit based on a normal activity of 20 000 units. The company also hires the machine on which the components are produced at a rate of £200 per month. Should the company make the component?