Question

Ren company manufactures 5,000 units of processor chip, A-403, each year for use on its production line. At this level of activity, the cost per unit of processor chip is:

Direct materials $        345

Direct labor 20

Variable manufacturing overhead 8

Fixed manufacturing overhead   80

Total manufacturing cost per unit $ 453

An outside supplier has offered to sell all units of processor chip the company requires. If the company decided to discontinue making processor chip, 80% of the above fixed manufacturing overhead costs could be avoided.

The company could use the facilities presently devoted to the production of processor chip to increase the production of another product by 2,500 units, which would yield an additional contribution margin of $100,000 annually.

Q:) What is the maximum price the company would be willing to pay the outside supplier for processor chip?

A:) $  per unit

Answer 1

Particulars	Amount (In $)
Cost to be incurred due to manufacture of processor chips:
Direct Material (5,000 units X $ 345 per unit)	1,725,000
Direct Labor (5,000 units X $ 20 per unit)	100,000
Variable manufacturing overhead (5,000 units X $ 8 per unit)	40,000
Avoidable fixed manufacturing overhead (5,000 units X $ 80 per unit X 80%)	320,000
Total Cost to be incurred due to manufacture of processor chips	2,185,000
Plus: Benefit to be achieved
Additional Contribution margin earned	100,000
Maximum Price that the company will be willing to pay to outside supplier	2,285,000
Number of units transferred	5,000
Maximum Price per unit	$457

Note:

Maximum price that the company will be willing to pay should be based on the relevant cost. Relevant cost includes cost to be incurred due to manufacture of processor chip plus benefit to be achieved due to manufacture of processor chip.