Question

Supler Corporation produces a part used in the manufacture of one of its products. The unit product cost is $21, computed as follows:

Direct materials	$	7
Direct labor		6
Variable manufacturing overhead		3
Fixed manufacturing overhead		5
Unit product cost	$	21

An outside supplier has offered to provide the annual requirement of 2,900 of the parts for only $13 each. The company estimates that 60% of the fixed manufacturing overhead cost above could be eliminated if the parts are purchased from the outside supplier. Assume that direct labor is an avoidable cost in this decision. Based on these data, the financial advantage (disadvantage) of purchasing the parts from the outside supplier would be:

Multiple Choice

• ($3) per unit on average

• $3 per unit on average

• $6 per unit on average

• ($8) per unit on average

Answer 1

	Supler Corporation
	Relevant cost of manufacturing
	Direct Material	$       7.00
	Direct Labor	$       6.00
	Variable Manufacturing cost	$       3.00
	Fixed Manufacturing cost($5*60%)	$       3.00
	Total Relevant cost	$    19.00
	Cost of purchase from outside supplier	$    13.00
	Net Advantage
	Relevant cost of purchasing	$    19.00
	Less: Cost of purchase from outside supplier	$   -13.00
Ans )	Net Advantage	$       6.00	per unit on average
	Relevant cost : All cost which influence the decision.
	Sunk cost: Cost which is not avoided,so irrelevant for decision, in this case 40% of fixed cost are sunk cost.