Question

A company needs 10,000 units of a component used in producing one of its products. The latest internal accounting reports show that the per unit manufacturing cost to be $150.00, variable manufacturing costs of $110.00 and fixed manufacturing cost of $40. The company recently received an offer from another manufacturer to produce the component for $144.00. If it buys the component on the outside 40% of the fixed manufacturing cost can be avoided.

Required:

a. If the company buys the component from the outside supplier at $144.00, what is the impact on income?
b. What price would make the company indifferent between making the component internally and having the outside supplier make it?

Answer 1

a.

	Cost of Making	Cost of Buying
Variable manufacturing cost	10,000 x 110= 1,100,000	0
Fixed manufacturing cost	10,000 x 40 = 400,000	400,000-160,000 = 240,000
Supplies price	0	10,000 x 144 = 1,440,000
Total Cost	$1,500,000	$1,680,000

If components is purchase from outside supplier Fixed manufacturing cost decrease by 40%

Decrease in Fixed manufacturing cost = 400,000 x 40%

= $160,000

If components is purchased from outside supplier fixed manufacturing cost will be = 400,000 - 160,000

= $240,000

Cost of buying from the outside supplier is $180,000 more than the cost of making. Hence, if component is bought from the outside supplier, net income of the company will decrease by $180,000.

b. Let the indifferent price be $Y

cost of making = Cost of buying

1,500,000 = 10,000Y + 240,000

10,000Y = 1,260,000

Y = $126

Hence, indifferent price = $126.

Kindly comment if you need further assistance. Thanks‼!