Question

Han Products manufactures 26,000 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 $ 5.70 Direct labor 7.00 Variable manufacturing overhead 4.00 Fixed manufacturing overhead 15.00 Total cost per part $ 31.70 An outside supplier has offered to sell 26,000 units of part S-6 each year to Han Products for $50.50 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 $753,800. 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

Answer 1

Computation of per unit and total relevant cost for buying and making the product

	Per unit cost		Total relevant cost (26,000 units)
Particulars	Make ($)	Buy ($)	Make ($)	Buy ($)
Cost of buying S-6		50.50		1,313,000
Cost of making S-6 :
Direct materials	5.70		148,200
Direct labor	7.00		182,000
Variable manufacturing overhead	4.00		104,000
Fixed manufacturing overhead ($15 * 1/3)	5.00		130,000
Total costs	$21.70	$50.50	$564,200	$1,313,000

Answer 2

If the outside supplier’s offer is accepted profit will increase by $5,000

Explanation :

Note : Oppotunity cost of making S-6 prodct = Annual rental = $753,800

Total cost of of buying S-6 = $1,313,000

Total cost of making S-6 (including oppotunity cost) = $564,200 + $753,800 = $1,318,000

Difference in costs = $1,313,000 - $1,318,000 = ($5,000).

Conclusion : Total costs decreases by $5,000 if the outside supplier’s offer is accepted. As we know, Decrease in costs = Increase in Profit , thus profit increases by $5,000.