Question

What in Articulation, Inc. produces music stands. In its current manufacturing environment, Articulation makes all of the bases used in production. When 100,000 bases are produced, the total direct product costs equal $80,000 and manufacturing overhead can be expressed as y = $2x + $70,000.

A potential outside supplier has been identified. If the bases are purchased from the outsider supplier, $15,000 of annual fixed manufacturing overhead costs will be avoided and the freed-up capacity could be used to expand production, resulting in a $45,000 increase in Articulation’s total contribution margin.

Answer the following questions:

1. Assume Articulation will need 125,000 bases in the next period. At what purchase price would Articulation be economically indifferent between making the bases and purchasing the bases from the outside supplier? Show your calculations.

2. Why would the amount calculated in 1. be important for a manager to know?

Answer 1

1. Computation of purchase price at which Articulation be economically indifferent between making the bases and purchasing the bases from the outside supplier:

The prices will be indifferent when the overall cost in the production and purchases are equal.

Direct Material product cost per unit = $80,000/100,000 units = $0.8 per unit

Manufacturing overhead expressed as y = $2x + $70,000 means $2 is the variable cost per unit and $70,000 is the fixed cost.

Computation of Indifferent price will be as follows:

So the company should not purchase 125,000 units for more than $410,000 i.e. $3.28 per unit ($410,000/125,000 units).

2. It is important for the manager to know the indifferent price as the manager is the one who decides whether the product will be purchased or it should be produced.

If the company gets the purchase price of more than $410,000 i.e. $3.28 per unit, then the company should produce it by themselves otherwise should purchase the units.

Hence, the indifferent price helps the manager to decide whether the product should be purchased or produced.