Question

Futura Company purchases the 64,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $12.20 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 $12.90 as shown below: Total Direct materials Direct labor Supervision Depreciation Variable manufacturing overhead Rent Per Unit $ 7.00 2.20 1.60 1.10 0.50 0.50 $12.90 $102,400 $ 70,400 $ 32,000 Total product cost If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $102,400) 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 $85,000 per period. Depreciation is due to obsolescence rather than wear and tear. Required: What is the financial advantage (disadvantage) of making the 64,000 starters instead of buying them from an outside supplier?

Answer 1

Solution -

The target level of production is 64000 starters, as shown by the relations between cost per unit and total fixed costs

Particulars Direct Materials Direct Labor Variable manufacturing overheads Suoervision Depreciation Rent Outside purchase price Total Cost Difference Cost per unit Make Buy $7.00 $7.00 $2.20 $2.20 $0.50 $0.50 $1.60 $1.60 $1.10 . $0.50 $12.20 $12.90 $11.30 $12.20 $0.90

so the relevant cost to make the starters is $11.30 because the fixed cost are unavoidable i.e dep. and rent so if the company would make the starters itself, it would result in a $.090 per starters cost savings or a total savings of $57600 (64000 * $0.90).

So the financial advantage is $57600 by making the starters instead of buying.