Question

Rudder Company prints a variety of publications and coloured inserts for newspapers. Currently, the company produces its own ink, including a special metallic colour. India Inks has offered to supply the company with the 25,000 mL of metallic ink that it needs each year for $1.24 per millilitre. The company is interested because this is a particularly difficult ink to make. Purchasing must make special efforts to locate suppliers; the metallic component requires special handling; and, since the metallic ink uses machinery that is also used to make other colours of ink, the machinery must be cleaned very well before every batch of metallic.

The accounting department supplied the following unit costs:

Direct materials		$0.40
Direct labour		$0.15
Variable overhead		$0.06
Fixed overhead*		$0.50
* Fixed overhead is applied on the basis of a plant-wide rate based on direct labour hours.

Use the excel document found in the Assignments tab to answer the questions below.

1. Based on the cost figures, if Rudder purchases metallic ink from the outside supplier, will operating income be higher or lower?
2. By how much?  
3. What is the highest price per millilitre that Rudder would pay an outside supplier for the ink?
4. Why is the answer above the highest price Rudder would pay an outside supplier for the ink?  

Answer 1

	Demand	25000
	Costs	Per unit cost	Cost for producing 25000 unit of link
	Direct materials	0.4	10000
	Direct labour	0.15	3750
	Variable overhead	0.06	1500
	Fixed overhead	0.5	12500
	Total cost of producing ink		27750
	If purchased from out side	Price per unit	1.24
	Total cost of purchasing from outside		31000
Ans a	If company purchased the ink from the outside then operating income will be lower
	3250	will be the difference if company buy ink from outside
Ans b and c	Highest price company can giver to the supplier should be same as the cost of producing
	the ink inhouse. So it will not reduce the operating income of the company
	It can be calculated by dividing the total cost of producing ink by the total demand
	That figure will give the highest price which should be given to supplier
	27750/25000	1.11
	So the company should pay 1.11 $/ milliliter to suplier