Question

Han Products manufactures 28,000 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	$	4.20
Direct labor		7.00
Variable manufacturing overhead		3.10
Fixed manufacturing overhead		15.00
Total cost per part	$	29.30

   

An outside supplier has offered to sell 28,000 units of part S-6 each year to Han Products for $48.50 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 $820,600. 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:

a.	Calculate the per unit and total relevant cost for buying and making the product? (Round your Per Unit answers to 2 decimal places.)

     

b.	How much will profits increase or decrease if the outside supplier’s offer is accepted?

    

      

Answer 1

Solution

Han Products

1. Calculation of per unit and total relevant cost for buying and making the product:

Han Products
		Per Unit Differential Costs		28,000 units
	Make	Buy	Make	Buy
Cost of purchasing		$48.50		$1,358,000
Cost of making:
Direct materials	$4.20		$117,600
Direct labor	$7.00		$196,000
Variable manufacturing overhead	$3.10		$86,800
Fixed overhead	$5.00		$140,000
Total cost	$19.30		$540,400

Note: avoidable portion of fixed cost is relevant for the decision making.

Avoidable fixed cost = 1/3^rd of fixed cost

One third of fixed cost = $15 x 1/3 = $5 per unit

1. Determination of increase or decrease in profits if outside supplier’s offer is accepted:

Cost of buying S-6 part = $1,358,000

Less: rental revenue from use of released facilities $820,600

Net cost of buying the part S-6 = 1,358,000 – 820,600 = $537,400

Net cost of making the part S-6 = $540,400

Cost of making is higher than cost of buying by $3,000        (540,400 – 537,400)

Hence, profits increase by $3,000 if the company accepts the outside supplier’s offer.