Question

Grand Limited currently produces a component of a product with the following per unit production costs:

Direct materials	$20.56
Direct labour	32.68
Overhead	18.53
Total production costs	$71.77

Grand Ltd. currently manufactures these components in-house, averaging production of 30668 units each year. A supplier has approach the company offering to supply 30668 units each year at a cost of $52.51 each.

60% of the overhead is fixed and if Grand Ltd. purchases the components, then 1/3 of the fixed overhead costs would be avoidable.

What is the maximum price that Grand should pay per unit for the component?

Select one:

a. $60.65

b. $64.36

c. $71.77

d. $59.42

Answer 1

Overhead per unit = $ 18.53

Fixed overhead per unit = Overhead per unit x 60 %

= 18.53 x 60 %

= $ 11.12

Avoidable fixed overhead per unit

= 11.12 x 1/3

= $ 3.71

Unavoidable fixed overhead per unit = Fixed overhead per unit - Avoidable fixed overhead per unit

= $ 11.12 - $ 3.71

= $ 7.41

Variable overhead per unit = Overhead per unit - Fixed overhead per unit

= $ 18.53 - $ 11.12

= $ 7.41

Calculation of maximum price that grand should pay per unit

Direct Material	20.56
Direct Labour	32.68
Variable Overhead	7.41
Avoidable Fixed Overhead	3.71
Total Price	$ 64.36

Hence, maximum price that grand should pay per unit = $ 64.36

Correct option is ( B )

Unavoidable fixed overhead is not relevant in deciding maximum price to be paid since it will be incurred whether the component is made or bought from the outside supplier.

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