Han Products manufactures 35,000 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 | $ | 3.90 |
Direct labor | 12.00 | |
Variable manufacturing overhead | 2.10 | |
Fixed manufacturing overhead | 9.00 | |
Total cost per part | $ | 27.00 |
An outside supplier has offered to sell 35,000 units of part S-6 each year to Han Products for $23 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 $85,000. 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?
Relevant costs to make = Direct materials + Direct labor + Variable manufacturing overhead + 1/3 fixed manufacturing overhead + Opportunity cost of lost rent
= $136,500 ($3.9*35,000) + $420,000 ($12*35,000) + $73,500 ($2.1*35,000) + $105,000 ($9*1/3*35,000) + $85,000
= $820,000
Relevant cost to buy = 35,000 * $23 = $805,000
Financial advantage = $820,000 - $805,000 = $15,000
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