Question

X Company is considering buying a part next year that it currently makes. This year's production costs for 3,200 units were:

                                                                          Per Unit               Total

Direct Materials	3.70	11,840
Direct Labor	3.00	9,600
Variable overhead	4.10	13,120
Fixed overhead	3.10	9920
Total	13.90	44,480

A company has offered to supply this part for $14.68 per unit. $4,662 of X Company's fixed overhead are allocated costs that will occur even if they buy the part. But if X Company buys the part, it can rent out the freed-up resources for $2,700. Production next year is expected to be 3,500 units.

1. If X Company continues to make the part instead of buying it, it will save

2.At what production level would X Company be indifferent between making and buying the part?

Answer 1

Answer 1

Cost of making parts in-house:

Direct Material	3.70
Direct Labour	3.00
Variable Overhead	4.10
	10.80
Variable Cost for 3500 Units	37,800
Fixed Cost	9,920
Total Cost	47,720

Cost of buying the parts:

Purchase Cost	14.68
Purchase Cost for 3500 units	51,380
Fixed Cost	4,662
Rent for idle resources	(2,700)
Total Cost	53,342

Thus, company X will save $ 5,662, if it continues making parts inside instead of buying the same.

Answer 2:

Production level where X Company will be indifferent between making and buying the part:

Additional Variable Cost of Buying from Outside= $3.88 per unit (14.68-10.80)

Savings in Fixed Cost if bought from Outside= $7,958(9920 - (4662-2700) = (9920-1962)

Thus, breakeven production level = $7958 / $3.88 = 2051.03 ~ 2051 units.

If annual requirement is more than 2051 units, company should produce parts in-house. However, if the annual requirement is less than 2051 units, it should purchase the same from outside market@ $14.68 per unit.