Question

Han Products manufactures 30,000 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	$	3.60
Direct labor		10.00
Variable manufacturing overhead		2.40
Fixed manufacturing overhead		9.00
Total cost per part	$	25.00

   

An outside supplier has offered to sell 30,000 units of part S-6 each year to Han Products for $21 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 $80,000. 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:

1.	Calculate the per unit and total relevant cost for buying and making the product? (Round your "per unit" answer to 2 decimal places.)

      

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

    

      

Answer 1

1. The per unit and total relevant cost for buying and making the product will be computed as follows:

	Per Unit Relevant Costs Make	Per Unit Relevant Costs Buys	30,000 Units Make	30,000 Units Buy
Cost of Purchasing		21		630000
Cost of Making:
Direct materials	3.6		108000
Direct labor	10		300000
Variable overhead	2.4		72000
Fixed overhead	3		90000
Total	19	21	570000	630000

Note: In a make or buy decision, relevant costs are costs that can be avoided if the company purchases the product from an outside spplier. Therefore, only $3 ($9 x 1/3) per unit of fixed overhead costs are relevant because $6 ($9 x 2/3) of fixed overhead costs are unavoidable.

2. The amount of increase or decrease in profits if outside supplier's offer is accepted will be computed as follows:

Total relevant costs to make = $570,000

If the company choses to buy the product from outside supplier, it could earn annual rent of $80,000.

Thus, $80,000 is the opportunity cost which is being incurred when the company makes the products.

Taking the opportunity cost into considration, total cost to make = $570,000 + $80,000 = $650,000

And,

Total relevant costs to buy = $630,000

Thus,

If the company choses to buy the product, its profit will increase by $20,000 ($650,000 - $630,000).