Question

X Company currently makes a part and is considering buying it next year from a company that has offered to supply it for $17.29 per unit. This year, total costs to produce 58,000 units were: Direct materials $371,200 Direct labor 336,400 Variable overhead 179,800 Fixed overhead 104,400 If X Company buys the part, it can avoid $34,452 of the fixed overhead. The resources that will become idle if they choose to buy the part can be used to increase production of another product, resulting in additional total contribution margin of $65,000. The marketing manager is uncertain what demand will be next year. What level of demand will make the company indifferent between making the part and buying it?

Answer 1

Direct material per unit = 371,200/58,000

= $6.4

Direct labor per unit = 336,400/58,000

= $5.8

Variable overhead per unit = 179,800/58,000

= $3.1

Variable cost per unit = 6.4 + 5.8 + 3.1

= $15.3

Fixed overhead = $104,400. If X Company buys the part, it can avoid $34,452 of the fixed overhead.

Unavoidable fixed cost = Fixed overhead - Avoidable fixed overhead

= 104,400 - 34,452

= $69,948

Let the demand at which the company will be indifferent between making the part and buying it = Y units

	Cost of making	Cost of buying
Supplier's price	0	17.29Y
Variable cost	15.3Y	0
Fixed cost	104,400	69,948
Additional contribution margin	0	- 65,000
Total cost	15.3Y + 104,400	17.29Y + 4,948

Hence, 15.3Y + 104,400 = 17.29Y + 4,948

1.99Y = 99,452

Y = 49,976 units

Hence, at demand of 49,976 units, the company will be indifferent between making the part and buying it.