Question

Han Products manufactures 18,000 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	$	5.00
Direct labor		6.00
Variable manufacturing overhead		2.80
Fixed manufacturing overhead		15.00
Total cost per part	$	28.80

   

An outside supplier has offered to sell 18,000 units of part S-6 each year to Han Products for $42.50 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 $431,600. 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:

a.	Calculate the per unit and total relevant cost for buying and making the product? (Round your Per Unit answers to 2 decimal places.)

     

b.	How much will profits increase or decrease if the outside supplier’s offer is accepted?

Answer 1

Answer 1. This part can be done by two ways:

first way :

calculation of relevant cost and per unit  of making 18,000 units:

Direct materials	$ 5.00	$ 90,000
Direct labor	6.00	$ 108,000
Variable manufacturing overhead	2.80	$ 50,40 0
Avoidable Fixed manufacturing overheads	5.00	$ 90,000
Opportunity cost	-	$ 431,600
Total	-	$ 770,000

*SINCE, 2/3 of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier. It means $ 10 per unit or $ 180,000 ( 18,000 * 10 ) will be non relevant cost while deciding about make or buy.

Cost of buying from an outsider = $ 42.50 per unit or $ 765,000 ( 42.50 * 18,000 units )

Second way:

Cost of company making 18,000 units :

Direct materials	$ 5.00	$ 90,000
Direct labor	6.00	$ 108,000
Variable manufacturing overhead	2.80	$ 50,400
Fixed manufacturing overheads	15.00	$ 270,000
Opportunity cost if company does not manufacture	-	$ 431,600
Total	-	$ 950,000

Cost of purchasing 18,000 units from outsiders

Actual cost $ 42.50 per unit = $ 765,000

Add: Unavoidable fixed manufacturing expenses ( 2/3 of $ 15 per unit ) = $ 180,000

Total cost = $ 765,000 + 180,000 = $ 945,000

Answer 2. according to first way,

cost of manufacturing 18,000 units on its own = $ 770,000

cost of purchasing 18,000 units from outsider = $ 765,000

Profits if the outside supplier’s offer is accepted = $ 5,000 ( 770,000 - 765,000 )

Han products should buy from outsider instead of manufacturing, Sice it would lead to $ 5,000 reduction in cost .