Question

Farrow Co. expects to sell 400,000 units of its product in the next period with the following results.

Sales (400,000 units)	$	6,000,000
Costs and expenses
Direct materials		800,000
Direct labor		1,600,000
Overhead		400,000
Selling expenses		600,000
Administrative expenses		1,028,000
Total costs and expenses		4,428,000
Net income	$	1,572,000

The company has an opportunity to sell 40,000 additional units at $13 per unit. The additional sales would not affect its current expected sales. Direct materials and labor costs per unit would be the same for the additional units as they are for the regular units. However, the additional volume would create the following incremental costs: (1) total overhead would increase by 15% and (2) administrative expenses would increase by $172,000.

Calculate the combined total net income if the company accepts the offer to sell additional units at the reduced price of $13 per unit. Should the company accept or reject the offer?

part two

Gilberto Company currently manufactures 69,000 units per year of one of its crucial parts. Variable costs are $2.15 per unit, fixed costs related to making this part are $79,000 per year, and allocated fixed costs are $66,000 per year. Allocated fixed costs are unavoidable whether the company makes or buys the part. Gilberto is considering buying the part from a supplier for a quoted price of $3.40 per unit guaranteed for a three-year period.

Calculate the total incremental cost of making 69,000 and buying 69,000 units. Should the company continue to manufacture the part, or should it buy the part from the outside supplier?

Answer 1

Part one

	Normal Volume (400000 units)	Additional Volume (40000 units)	Total
Sales	$6000000	$520000	$6520000
Costs and expenses
Direct materials	800000	80000	880000
Direct labor	1600000	160000	1760000
Overhead	400000	60000	460000
Selling expenses	600000	-	600000
Administrative expenses	1028000	172000	1200000
Total cost and expenses	4428000	472000	4900000
Net income	$1572000	$48000	$1620000

Calculation on additional volume

Sales= 40000*$13= $520000

Direct materials= ($800000/400000)*40000= $80000

Direct labor= ($1600000/400000)*40000= $160000

Overhead= $400000*15%= $60000

The company should accept the offer as the net income of the company will increases when the company accepted the offer.

Part two

	Manufacture the Part	Buy the Part
Variable cost	(69000*$2.15)= $148350	-
Fixed manufacturing costs	79000	-
Purchase price	-	(69000*$3.40)= 234600
Total relevant cost	$227350	$234600

The company should manufactured the part as the total relevant cost of manufacturing the part is less than buying the part.

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