Question

Kirsten Corporation makes 100,000 units per year of a part called a B345 gasket for use in one of its products. Data concerning the unit production costs of the B345 gasket follow:

Direct materials	$	0.15
Direct labor		0.10
Variable manufacturing overhead		0.13
Fixed manufacturing overhead		0.24
Total manufacturing cost per unit	$	0.62

An outside supplier has offered to sell Kirsten Corporation all of the B345 gaskets it requires. If Kirsten Corporation decided to discontinue making the B345 gaskets, 25% of the above fixed manufacturing overhead costs could be avoided. Assume that direct labor is a variable cost.

Required:

a. Assume Kirsten Corporation has no alternative use for the facilities presently devoted to production of the B345 gaskets. If the outside supplier offers to sell the gaskets for $0.46 each, should Kirsten Corporation accept the offer? Fully support your answer with appropriate calculations.

b. Assume that Kirsten Corporation could use the facilities presently devoted to production of the B345 gaskets to expand production of another product that would yield an additional contribution margin of $10,000 annually. What is the maximum price Kirsten Corporation should be willing to pay the outside supplier for B345 gaskets?

Answer 1

a.

	Make	Buy	Net Income Increase (Decrease)
Direct materials	15000	0	15000
Direct labor	10000	0	10000
Variable overhead	13000	0	13000
Fixed overhead	24000	18000	6000
Purchase price	0	46000	-46000
Total annual cost $	62000	64000	-2000

Kirsten Corporation should not accept the offer.

Accepting the offer will result in a decrease in net income by $2000 hence, Kirsten Corporation should not accept the offer of the outside supplier.

b. Financial advantage from buying the part:

Direct materials	15000
Direct labor	10000
Variable overhead	13000
Fixed overhead	6000
Opportunity cost	10000
Total financial advantage $	54000

Maximum price per unit = $54000/100000 = $0.54