Question

Futura Company purchases the 65,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $12.30 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 $12.30 as shown below: Per Unit $ 6.00 Total Direct materials Direct labor 2.80 1.70 $110,500 1.00 65, 000 Supervision Depreciation Variable manufacturing overhead 0.50 0.30 19,500 Rent Total production cost $12.30 be hired (at a salary of $110,500) to oversee production. However, If Futura decides to make the starters, a supervisor would have 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 $89,000 per period. Depreciation is due to obsolescence rather than wear and tear. Required: What is the financial advantage (disadvantage) of making the 65,000 starters instead of buying them from an outside supplier?

Answer 1

ANSWER:

INCREMENTAL ANALYSIS:

Particulars	Make	Buy
Direct material (65000 x $6)	$390000
Direct labor (65000 x $2.80)	$182000
Supervision (65000 x $1.70)	$110500
Variable manufacturing overhead (65000 x $0.50)	$32500
purchase cost (65000 x $12.30)	-	$799500
Total relevant cost	$715000	$799500

Therefore,

financial advantage = $799500 - $715000 = $84500