Question

29. Auto parts limited has an annual production of 90,000 units for a motor component. The component’s cost structure per unit is given below: Materials Rs. 2.70; labour (25% fixed) Rs. 180; Variable Expenses Rs. 90; Fixed Expenses Rs. 135; Total Rs. 675; The purchase manager has an offer from a supplier who is willing to supply the component at Rs. 540. Should the component be purchased? Assuming that the resources now used for the purpose of this components manufacture can be used to produce a new product for which the selling price is Rs. 485, is it advisable to divert the resources for producing the new product, if it uses materials of Rs. 2.00 per unit and has the same cost for labour and expenses.

Answer 1

Auto parts limited
Relevant cost per unit	Amount $
Direct materials	270.00
Direct labor (75% variable)	135.00
Variable overhead	90.00
Relevant cost per unit	495.00
Offer price	540.00
Net loss per unit	45.00
Company will lose $ 45 per unit if purchased from outside. So it should not buy and only make.
Auto parts limited
Contribution margin from new product	Amount $
Direct materials	2.00
Direct labor	180.00
Variable overhead	90.00
Relevant cost per unit	272.00
Sell price per unit	485.00
Contribution margin from new product	213.00
Company will earn $ 213 per unit from new product. So it should buy and not make.