Question

Hale Company makes sets of wrenches. They are trying to decide whether to continue to make the case the wrenches are sold in, or to outsource it to another company. The direct material and direct labor cost to produce the cases total $2.00 per case. The overhead cost is $1.00 per case which consists of $0.40 in variable overhead which would all be eliminated if the case were bought from the outside supplier. The $0.60 of fixed overhead is based on expected production of 200,000 cases per year and consists of the salary of the case production manager of $40,000 per year and $80,000 in depreciation on equipment that would have no resale value. The manager would be laid off if the cases were bought externally. Additionally, if the case production were stopped, the space that it is using could be rented out for $20,000 per year. The outside supplier has offered to supply the cases for $2.80 per case. How much will Alan save or lose if the cases are bought externally?

A. Save $0.40 per case

B. Lose $0.20 per case

C. Lose $0.80 per case

D. Save $0.20 per case

Answer 1

1) Differential analysis

	Make	Buy
Direct material and direct labor	2
Variable overhead	0.40
Fixed overhead avoidable (40000/200000)	0.20
Opportunity Cost	0.10
Purchase cost		2.80
Total relevant cost	2.70	2.80

Save = (2.60-2.80) = 0.20

So answer is d) Save $0.20 per case