Question

Royal Company manufactures 10,000 units of Part R-3 each year. At this level of activity, the cost per unit for Part R-3 follows:

Direct materials	$14.40
Direct labour	21.00
Variable manufacturing overhead	9.60
Fixed manufacturing overhead	25.00
Total cost per part	$70.00

An outside supplier has offered to sell 10,000 units of Part R-3 each year to Royal Company for $54 per part. If Royal Company accepts this offer, the facilities now being used to manufacture Part R-3 could be rented to another company at an annual rental of $150,000. However, Royal Company has determined that $15 of the fixed manufacturing overhead being applied to Part R-3 would continue even if the part were purchased from the outside supplier.

Required:

1. Prepare computations showing how much profits will increase or decrease if the outside supplier’s offer is accepted.

Exercise 12-16 MAKE OR BUY COMPONENT The costs that are relevant in a make-or-buy decision are those costs that can be avoided as a result of purchasing from the outside. The analysis for this exercise is: Per Unit Differential Costs 10,000 Units Make Buy Make Buy Cost of purchasing. Cost of making: Direct materials... Direct labour..... Variable manufacturing overhead Fixed manufacturing overhead... Total cost.. * The remaining $. of fixed manufacturing overhead cost would not be relevant, since it will continue regardless of whether the company makes or buys the parts. The $150,000 rental value of the space being used to produce part R-3 represents an opportunity cost of continuing to produce the part internally.

Answer 1

1. $10 fixed manufacturing overhead cost are relevant.

	per unit	Total fro 10,000 units
	Make	Buy	Make	Buy
cost of purchasing		$54	-	$540,000[$54*10,000]
cost of making
Direct Material	$14.40		$144,000 [14.40*10,000]
Direct labor	$21		$210,000[21*10,000]
variable overhead	$9.60		$96,000 [9.60*10,000]
FixedOH	$10		$100,000 [10*10,000]
Total cost			$550,000	$540,000

remaining fixed cost [$15*10,000] $ 15 /$150,000 will not be relevant

	Make	buy
Total cost	$550,000	$540,000
Opportunity cost	$150,000	0
Total cost incl. Opportunity cost	$700,000	$540,000

Net advantage of buying [$700,000-540,000]$160,000

profit would increase by $160,000 if bought from outside.

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