Question

X Company is considering buying a part next year that it currently makes. A company has offered to supply this part for $15.34 per unit. This year's total production costs for 59,000 units were:

Materials	$300,900
Direct labor	241,900
Total overhead	383,500

$265,500 of X Company's total overhead costs were variable; $34,220 of X Company's fixed overhead costs can be avoided if it buys the part. If X Company buys the part, there are no alternative uses of the resources that were used for its production. Production next year is expected to increase to 63,850 units.

1. If X Company continues to make the part instead of buying it, it will save $70,494

2. X Company has an opportunity to negotiate the purchase price with the supplier. What purchase price would make X Company indifferent between making and buying? _________

Answer 1

Let's arrange the given information :

particulars	total	per unit
material	$300900	5.1
labour	$241900	4.1
variable overhead	$265500	4.5
fixed overhead*	$118000	2
total units	59000	15.7

*total overheads - variable overhead = fixed overhead = 383500 - 265500

1. If X Company continues to make the part instead of buying it, it will save? $70494

cost of making - the cost of buying = savings.

let us compute the cost of making the part for 63850 units

material	63850*5.1 = 325635
labour	63850*4.1 = 261785
variable overhead	63850*4.5 = 287325
fixed overhead**	34220
total	908965
cost per unit	908965/63850 = 14.2359436178

**fixed overhead, in the cost of making, is the avoidable fixed overhead cost if the part is purchased.

The reason is very simple as the unavoidable fixed overhead is to occur regardless of the purchase or production of the part. But the avoidable fixed overhead depends on the making of the part, hence added to the cost of making.

cost of buying per unit = 15.34$

savings= (15.34 - 14.2359436178) * 63850 = $70494

2) X Company has an opportunity to negotiate the purchase price with the supplier. What purchase price would make X Company indifferent between making and buying? _________ $14.24

At the indifferent point, the cost buying = cost of making

==> 14.2359436178 is the indifferent purchase price

rounded off to $14.24.