Question

Exercise 12-11 Make or Buy Decision (LO12-3) Han Products manufactures 36,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total cost per part $ 4.00 8.00 2.00 9.00 $ 23.00 An outside supplier has offered to sell 36,000 units of part 5-6 each year to Han Products for $19 per part. If Han Products accepts this offer, the facilities now being used to manufacture part 5-6 could be rented to another company at an annual rental of $86,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part 5-6 would continue even if part S-6 were purchased from the outside supplier. Required: What is the financial advantage (disadvantage) of accepting the outside supplier's offer?

Answer 1

Total cost to make = $23 X 36,000 = $828,000

2/3 of fixed manufacturing overhead will be incurred even if units are purchased.

Unavoidable fixed cost = $9 X 2/3 = $6

$86,000 annual rental income will be earned if units are purchased.

Total cost to buy = ($19 + $6) X 36,000 - $86,000 = $814,000

Cost to buy is less than cost to make. Hence there is a financial advantage if units are purchased.

Financial advantage = $828,000 - $814,000 = $14,000