Question

Davis Kitchen Supply produces stoves for commercial kitchens. The costs to manufacture and market the stoves at the company's normal volume of 6,000 units per month are shown in the following table.

Unit manufacturing costs
Variable materials	$	52
Variable labor		77
Variable overhead		27
Fixed overhead		62
Total unit manufacturing costs				$	218
Unit marketing costs
Variable		27
Fixed		72
Total unit marketing costs					99
Total unit costs				$	317

e-1. A proposal is received from an outside contractor who will make and ship 2,000 stoves per month directly to Davis’s customers as orders are received from Davis’s sales force. Davis’s fixed marketing costs would be unaffected, but its variable marketing costs would be cut by 20 percent for these 2,000 units produced by the contractor. Davis’s plant would operate at two-thirds of its normal level, and total fixed manufacturing costs would be cut by 25 percent. What in-house unit cost should be used to compare with the quotation received from the supplier? Assume the payment to the outside contractor is $217.

In-house cost savings per unit

f-1. A proposal is received from an outside contractor who will make and ship 2,000 stoves per month directly to Davis’s customers as orders are received from Davis’s sales force. Davis’s fixed marketing costs would be unaffected, but its variable marketing costs would be cut by 20 percent for these 2,000 units produced by the contractor. The idle facilities would be used to produce 1,600 modified stoves per month for use in extreme climates. These modified stoves could be sold for $452 each, while the costs of production would be $277 per unit variable manufacturing expense. Variable marketing costs would be $52 per unit. Fixed marketing and manufacturing costs would be unchanged whether the original 6,000 regular stoves were manufactured or the mix of 4,000 regular stoves plus 1,600 modified stoves were produced. What in-house unit cost should be used to compare with the quotation received from the outside contractor? Assume the payment to the outside contractor is $217.

	In-house cost savings per unit

f-2. Should the proposal be accepted for a price of $217 per unit to the outside contractor?

	In-house cost savings per unit

Answer 1

In-house savings per unit = Costs avoided

= Variable material + Variable labor + Variable overhead + Fixed overhead avoided + Marketing costs avoided

= 52+77+27+(62*6000*25%)/2000 + 27*20%

= $207.9 per unit

Hence, the offer should not be accepted since in-house cost is lower

f-1

In house cost = Avoidable cost + Opportunity cost of not producing modified stoves

= 52+77+27 + 5.4 + (452-277-52)*1600/2000

= $259.8 per unit

Hence, the proposal should be accepted