Question

murray corp currently makes 6470 subcomponents a year in one of its factories. The unit cost of produce are:

Direct materials $4

direct labor $2

variable manufacturing overhead 1

fixed manufacturing overhead 2

an outside supplier has offered to provide murray corp with the 6470 sub components are a $16 per unit price. Fixed overhead is not available. if murray corp decides to buy from the outside supplier, the impact of net income will be?

fixed overhead is not avoidable *****

Answer 1

Answer)

Calculation of Increase/ Decrease in Net income if company decides to procure subcomponents from Outside market

The purchase cost per subcomponent is $ 16. Since the company requires 6,470 subcomponents, the total purchase cost will be:

Total purchase cost = Number of components X purchase cost per component

                                    = 6,470 X $ 16.00

                                    = $ 103,520

On the contrary, the relevant cost to manufacture component in house is $ 45,290   (Refer Working Note)

If the company decides to purchase the component from outside supplier, its financial impact will be:

Decrease in Net Income = Total cost of purchase – Relevant cost of manufacture

                                            = $ 103,520 - $ 45,290

                                            = $ 58,230.

Therefore, if the company decides to purchase the component from outside supplier, its Net Income will decrease by $ 58,230.

Working Note:

Calculation of relevant cost to manufacture 6,470 sub components

Particulars	Per Unit (in $)	Total for 6,470 Components (In $)
Relevant Cost:
Direct Material	4.00	25,880
Direct Labor	2.00	12,940
Variable Manufacturing overheads	1.00	6,470
Total	7.00	45,290

Fixed manufacturing overhead:

Fixed manufacturing overhead $ 2.00 per unit or $ 12,940 in Total (6,470 components X $ 2.00 per component) has not been considered in above decision making as it is a sunk cost, being unavoidable in nature (i.e. it will be incurred irrespective of whether the company decides to manufacture the component In house or purchase it from outside supplier).