Question

Ralston Company makes 10,000 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows: Direct materials $13.20 Direct labor 20.80 Variable manufacturing overhead 3.00 Fixed manufacturing overhead 10.90 Unit product cost $47.90 An outside supplier has offered to sell the company all of these parts it needs for $42.30 a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be $39,000 per year. If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, $6.40 of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the company's remaining products. Required: a. What is the net total dollar advantage (disadvantage) of purchasing the part rather than mak it? b. What is the maximum amount the company should be willing to pay an outside supplier per unit for the part if the supplier commits to supplying all 10,000 units required each year?

Answer 1

a) Differential analysis

	Make	Buy
Direct material	10000*13.20 = 132000
Direct labor	208000
Variable manufacturing overhead	30000
Fixed manufacturing overhead (10.90-6.4)	45000
Opportunity Cost	39000
Purchase cost (10000*42.30)		423000
Total Cost	454000	423000

Net advantage of Purchasing = 454000-423000 = 31000

b) Maximum price = 454000/10000 = $45.40