Question

Futura Company purchases the 65,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $10.80 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $11.30 as shown below:

	Per Unit			Total
Direct materials	$	4.00
Direct labor		3.50
Supervision		1.50		$	97,500
Depreciation		1.00		$	65,000
Variable manufacturing overhead		0.80
Rent		0.50		$	32,500
Total production cost	$	11.30

If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $97,500) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $80,000 per period. Depreciation is due to obsolescence rather than wear and tear.

Required:

What is the financial advantage (disadvantage) of making the 65,000 starters instead of buying them from an outside supplier?

Answer 1

Answer -

Calculation of the Financial advantage (disadvantage) of making the 65000 starters -

	Particulars	Calculations	Amount ($)
A.	Cost of Buying	[65000 units * $10.80 per unit]	702000
	.
	Cost of Making	-	-
	Direct materials	[65000 units * $4.00 per unit]	260000
	Direct labor	[65000 units * $3.50 per unit]	227500
	Supervision	Given in question	97500
	Variable manufacturing overhead	[65000 units * $0.80 per unit]	52000
B.	Total Cost of Making	$260000+$227500+$97500+$52000	637000
	.
Financial Advantage		A - B	65000

Note - Depreciation and Rent are fixed cost, so they are irrelevant.