Question

Han Products manufactures 35,000 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	$	3.90
Direct labor		12.00
Variable manufacturing overhead		2.10
Fixed manufacturing overhead		9.00
Total cost per part	$	27.00

An outside supplier has offered to sell 35,000 units of part S-6 each year to Han Products for $23 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 $85,000. 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:

What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?

Answer 1

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Financial Advantage of accepting outside supplier's offer	=	$          15,000
Workings:
	Make	Buy	Difference
	(a)	(b)	(a) - (b)
Direct material (35000 X $3.9)	$      1,36,500	0	$   1,36,500
Direct labor (35000 X $12)	$      4,20,000	0	$   4,20,000
Variable manufacturing overhead (35000 X $2.10)	$          73,500	0	$      73,500
Fixed manufacturing overhead traceable (35000 X $9) (35000 X $9 X 2/3)	$      3,15,000	$      2,10,000	$   1,05,000
Opportunity Cost	$          85,000	0	$      85,000
Purchase Price (35000 X $23)	0	$      8,05,000	$ -8,05,000
Total cost	$    10,30,000	$    10,15,000	$      15,000