Question

Hamilton Company purchases the 63,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $12.60 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $12.70 as shown below:

	Per Unit			Total
Direct materials	$	6.00
Direct labor		3.20
Supervision		1.40		$	88,200
Depreciation		1.20		$	75,600
Variable manufacturing overhead		0.40
Rent		0.50		$	31,500
Total product cost	$	12.70

If Hamilton decides to make the starters, a supervisor would have to be hired (at a salary of $88,200) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $85,000 per period. Depreciation is due to obsolescence rather than wear and tear.

Required:

What is the financial advantage (disadvantage) of making the 63,000 starters instead of buying them from an outside supplier?

Answer 1

Answer:- The financial advantage of making the starters instead of buying them from outside supplier is $100800.

Explanation- The company should make the starters, rather than continuing to buy from the outside supplier. Making the starters provides a per unit financial advantage of 1.60 per starter ($12.60 per unit – $11.00 per unit = $1.60 per unit), or a total financial advantage of $100800 per period (ie- $1.60 per starter *63000 starters = $100800).

HAMILTON COMPANY
Statement of Comparative cost
Manufacturing	Amount	Purchase from outside Supplier	Amount
Alternative 1	$ per unit	Alternative 2	$ per unit
Direct Material	6.00	Purchase Cost	12.60
Direct Labor	3.20
Supervision	1.40
Variable manufacturing overhead	0.40
Total Manufacturing cost	$11.00	Total Purchase cost	$12.60

Where- Depreciation cost is sunk cost & rent is a allocated/unavoidable cost, which both are not relevant for decision making, hence should be ignored.