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		6.00
Variable manufacturing overhead		2.20
Fixed manufacturing overhead		15.00
Total cost per part	$	27.40

   
An outside supplier has offered to sell 28,000 units of part S-6 each year to Han Products for $39.50 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 $603,800. 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" answers to 2 decimal places.)

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

Answer 1

Requirement 1

Differential Analysis
	Make	Buy	Income Increase(decrease)
Direct material	$      4.20		$       4.20
Direct labor	$      6.00		$       6.00
Variable Manufacturing Overheads	$      2.20		$       2.20
Opportunity cost	$    21.56
Avoidable fixed cost	$      5.00
Purchase price		$      39.50	$ (39.50)
Total Relevant Cost	$    38.96	$      39.50	$ (27.10)

Differential Analysis
	Alternative 1(Make)	Alternative 2 (Buy)	Income Increase(decrease)
Direct material	$       117,600.00		$         117,600.00
Direct labor	$       168,000.00		$         168,000.00
Variable Manufacturing Overheads	$         61,600.00		$           61,600.00
Avoidable Fixed Cost	$       140,000.00		$         140,000.00
Purchase price	$                        -	$ 1,106,000.00	$   (1,106,000.00)
Opportunity cost	$       603,800.00
Total Relevant Cost	$   1,091,000.00	$ 1,106,000.00	$         (15,000.00)

Requirement 2

Profit will decrease by $15000 if offer is accepted

This is because relevant cost of production is lower than purchase from outside.

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