Question

McMurphy Corporation produces a part that is used in the manufacture of one of its products. The costs associated with the production of 12,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $86,000 126,000 58,000 138,000 $408,000 Of the fixed factory overhead costs, $55,000 is avoidable. Conners Company has offered to sell 12,000 units of the same part to McMurphy Corporation for $41 per unit. Assuming there is no other use for the facilities, Schmidt should O A. make the part, as this would save $14 per unit OB. buy the part, as this would save the company $192,000 O c. buy the part, as this would save $16 per unit OD. make the part, as this would save $16 per unit

Answer 1

Relevant costs are costs that are incurred only when production is done. In order to decide whether to make or buy, we have to compare the relevant costs per unit with the cost of buying per unit

Relevant costs are variable costs and avoidable fixed costs which will not be incurred if production is not done. All other costs ( non-avoidable fixed costs ) are sunk costs as they will be incurred even of production I not done. So, these costs are not relevant for the purpose of decision making

So, Total revenant costs

= Direct Materials + Direct Labor + Variable Factory Overhead + Avoidable fixed overhead

= $86,000 + $126,000 + $58,000 + $55,000

= $325,000

Number of units = 12,000

So, Relevant costs per unit

= Total relevant costs / Number of units

= $325,000 / 12,000

= $ 27.08 per unit

Cost of buying = $41 per unit

So, Savings per unit if production is done instead of buying

= Purchase cost per unit – Relevant production costs per unit

= $41 - $27.08

= $13.92 or $14 per unit

So, as per above discussion, option A is the correct option