Question

Han Products manufactures 33,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is:

Direct Materials: $3.70

Direct Labor: $10.00

Variable manufacturing overhead: $2.30

Fixed manufacturing overhead: $12.00

Total cost per unit: $28.00

An outside supplier has offered to sell 33,000 units of part S-6 each year to Han Products for $22 per part. If Han Products accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental of $83,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier.

Required:

What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?

Answer 1

	Per unit		Total 33000 units
	Make	Buy	Make	Buy
Direct materials	3.70		122100
Direct labor	10.00		330000
Variable manufacturing overhead	2.30		75900
Fixed manufacturing overhead avoidable	4.00		132000
Opportunity cost			83000
Purchase cost		22		726000
Total			743000	726000
Difference in favor of buying = 743000-726000 = $17000
Financial advantage = 17000