Suppose Country Cafe restaurant is considering whether to (1) bake bread for its restaurant in-house or (2) buy the bread from a local bakery. The chef estimates that variable costs of making each loaf include $ 0.52 of ingredients, $ 0.23 of variable overhead (electricity to run the oven), and $ 0.78 of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor, Country Cafe assigns $ 1.04 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge $ 1.74 per loaf.

Question

Suppose Country Cafe restaurant is considering whether to (1) bake bread for its restaurant in-house or (2) buy the bread from a local bakery. The chef estimates that variable costs of making each loaf include $ 0.52 of ingredients, $ 0.23 of variable overhead (electricity to run the oven), and $ 0.78 of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor, Country Cafe assigns $ 1.04 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge $ 1.74 per loaf.

Answer

Explanation:

Absorption cost= Direct cost + Variable overhead + Fixed overhead

                   = 0.52 + 0.23+ 0.78 + 1.04

                   = $2.57

Variable cost of making the loaf= Direct cost + Variable overhead

                     =0.52 + 0.23+ 0.78 = $1.53

                                                                               $

Variable cost of making                                     1.53

External purchase price                                      1.74

Extra cost of external purchase per unit            0.21

It will be cheaper for Country Cafe to produce internally that to buy from outside as it will save $0.21 per unit of bread

Non-Financial factors

Product Quality. Country Cafe needs to be sure that the quality of bread to be provided wont be undermined.  should it decides to buy.

Trade secret: is there a guarantee that the contractor would not divulge or abuse the privileged information about the ingredients to be mixed and some other trade secrets

Delivery : Reliable and timely delivery are very important. Would the external supplier be able to meet expectations?