Question

Han Products manufactures 28,000 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	$	4.20
Direct labor		6.00
Variable manufacturing overhead		3.90
Fixed manufacturing overhead		18.00
Total cost per part	$	32.10

   

An outside supplier has offered to sell 28,000 units of part S-6 each year to Han Products for $41.00 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 $598,200. 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

a. The relevant costs for making and buying the product are calculated as under:

Note 1 : Since 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, hence it would be irrelevnt for decision making and therefore only balance one third are considered in relevant costs.

b. From the above calculations we can see that costs are lower if the outside supplier’s offer is accepted. The increase in profits will be equal to savings in costs i.e 562,800 - 549,800 = $13,000