Question

Futura Company purchases the 72,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $11.70 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $12.80 as shown below:

	Per Unit			Total
Direct materials	$	6.00
Direct labor		2.80
Supervision		2.00		$	144,000
Depreciation		1.10		$	79,200
Variable manufacturing overhead		0.40
Rent		0.50		$	36,000
Total product cost	$	12.80

If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $144,000) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $86,000 per period. Depreciation is due to obsolescence rather than wear and tear.

Required:

What is the financial advantage (disadvantage) of making the 72,000 starters instead of buying them from an outside supplier?

Answer 1

	Make	Buy
Direct material (72000*6)	432000
Direct labor (72000*2.8)	201600
Supervision	144000
Variable manufacturing overhead (72000*.40)	28800
Purchase cost (72000*11.70)		842400
Total relevant cost	806400	842400

Financial advantage = 842400-806400 = 36000

Answer 2

	Relevant Cost
Item	Make	Buy	Financial   Advantage / (Disadvantage) of Making
Direct Material	$          432,000		$            432,000	(72000*6)
Direct Labor	$          201,600		$            201,600	(72000*2.8)
Supervision	$          144,000		$            144,000
Variable Manufacturing Overhead	$            28,800		$              28,800	(72000*0.4)
Cost of   purchasing from outside supplier		$          842,400	$         (842,400)	(72000*11.7)
Total Cost	$          806,400	$          842,400	$              36,000
Financial advantage	$            36,000
Note :   Rent is fixed and allocated cost, actual rent does not change in both the   cases whether we make or buy hence rent is ignored in decision making.