Question

Mcfarlain Corporation is presently making part U98 that is used in one of its products. A total of 7,000 units of this part are produced and used every year. The company's Accounting Department reports the following costs of producing the part at this level of activity: Per Unit Direct materials $ 3.50 Direct labor $ 4.50 Variable overhead $ 1.90 Supervisor's salary $ 5.50 Depreciation of special equipment $ 5.50 Allocated general overhead $ 6.00 An outside supplier has offered to produce and sell the part to the company for $25.10 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company, none of which would be avoided if the part were purchased instead of produced internally. In addition to the facts given above, assume that the space used to produce part U98 could be used to make more of one of the company's other products, generating an additional segment margin of $23,200 per year for that product. What would be the financial advantage (disadvantage) of buying part U98 from the outside supplier and using the freed space to make more of the other product?

Answer 1

Differential analysis

	Make	Buy
Direct material	7000*3.5 = 24500
Direct labor	7000*4.5 = 31500
Variable overhead	7000*1.9 = 13300
Supervisory salary	7000*5.5 = 38500
Purchase cost		7000*25.10 =175700
Opportunity Cost	23200
Total relevant cost	131000	175700

Financial (disadvantage) = 131000-175700 = -44700