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Two recent graduates decided to open a bagel shop. Their first decision is whether they should make the bagels on-site or buy the bagels from a local bakery.
If they buy from the local baker, they will need new containers to store the bagels. The fixed cost for buying the containers is $1,000 annually.
The baker will sell the bagels for $.40 each.
If they make the bagels in-house, they will need to buy a kitchen with a fixed cost of $15,000 annually and a variable cost per bagel of $0.15.
They believe they will sell 60,000 bagels in the first year.
a) Should they buy or make the bagels?
b) If they are uncertain as to the demand of the bagels for next year, what is the indifference point between making or buying the bagels?
FC b= fixed cost to buy = $1,000
VCb = Variable cost to buy = $.40
Q = quantity = 60,000
FCm – fixed cost to make = $15,000
VCm = variable cost to make = .15
Q = quantity = 60,000
Set total annual costs:
FCb + (VCb x Q) = FCm + (VCm x Q)
Solving for Q, we have (0.25Q) = $14,000, or Q = 56,000 bagels