Question

X Company is considering buying a part next year that it currently makes. A company has offered to supply this part for $17.18 per unit. This year's total production costs for 57,000 units were:

Materials $387,600

Direct labor 285,000

Total overhead 290,700

$205,200 of X Company's total overhead costs were variable; $24,795 of X Company's fixed overhead costs can be avoided if it buys the part. If X Company buys the part, there are no alternative uses of the resources that were used for its production. Production next year is expected to increase to 60,400 units.

a.) If X Company continues to make the part instead of buying it, it will save $82,717

b.) X Company has an opportunity to negotiate the purchase price with the supplier. What purchase price would make X Company indifferent between making and buying?

Answer 1

Answer

a.

Fixed Overhead Cost = Total Overhead Cost – Variable Overhead Cost

Fixed Overhead Cost = $85,500 ($290,700 – 205,200)

It is mentioned that Out of Total Fixed Overhead cost, $24,795 Fixed Overhead Cost is Avoidable, rest will sill incur if we buy this product.

Particulars	Produce		Buy
	Per Unit	Total	Per Unit	Total
D Material	6.80	410,720.00	-	-
D Labor	5.00	302,000.00	-	-
Overhead
Variable	3.60	217,440.00	-	-
Fixed	1.42	85,500.00	-	60,705.00
Buying Cost	-			1,037,672.00
Total Cost		1,015,660.00		1,098,377.00

Company will save $82,717 (1,098,377 – 1,015,660)

b.

Let’s take company needs 60,400 Units (As in part a)

Total Cost of Manufacturing 60,400 Products = $1,015,660, So Company doesn’t want to pay more than this.

Cost of Buying = Cost of Manufacturing = $1,015,660

Cost of Buying = Fixed Cost non-avoidable + Buying Cost (60,400 Units * Purchase price)

1,015,660 = 60,705 + (60,400 * Price)

60,400 * Price = 954,955 (1,015,660 - 60,705)

Price = $15.8105 (954,955 / 60,400 Units)

Purchase price that would make X Company indifferent between making and buying = $15.81

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