Objective 2 Example 8.1 Fresh Foods, a large restaurant chain, needs to determine if it would be cheaper to produce 5,000 units of its main food ingredient for use in its restaurants or to purchase them from an outside supplier for $12 each. Cost information on internal production includes the following: Direct materials Direct labor Variable manufacturing overhead Variable marketing overhead Fixed plant overhead Total Total Cost Unit Cost $ 5.00 3.00 1.50 2.00 6.00 $17.50 $25,000 15,000 7,500 10,000 30,000 $87,500

Fixed overhead will continue whether the ingredient is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price. Required: 1. What are the alternatives for Fresh Foods? 2. List the relevant cost(s) of internal production and of external purchase. 3. Which alternative is more cost effective and by how much? 4. Now assume that 20% of the fixed overhead can be avoided if the ingredient is purchased externally. Which alternative is more cost effective and by how much