Question

Han Products manufactures 42,500 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 as follows:

  

Direct materials	$	4.75
Direct labour		10.75
Variable overhead		3.75
Fixed overhead		9.75
Total cost per part	$	29.00

  

An outside supplier has offered to sell 42,500 units of part S-6 each year to Han Products for $25.75 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 $94,000. However, Han Products has determined that two-thirds of the fixed overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier. Required: What is the net dollar advantage or disadvantage of accepting the outside supplier’s offer? (Do not round intermediate calculations)

Answer 1

Solution:

Offered Price by outside supplier = $25.75 per unit

We need to compare here the what will be the cost if company make product or purchase from outside.

Now, the question start with Relevant Cost.

In making the product in house, the company will incur Direct material, direct labor and variable manufacturing overhead. These are treated as relevant cost for calculating advantage or disadvantage of offer.

Relevant Cost is the cost which will incur in future and different under each alternative course of action. In other words, if company accept offer these cost will not incur and if company not accept the offer these cost will incur in making the product. Hence these are relevant cost.

Advantage or disadvantage of accepting the outside supplier’s offer

	Make	Buy
Direct Materials	$201,875 (42500*4.75)
Direct Labors	$456,875 (42500*10.75)
Variable Overheads	$159,375 (42500*3.75)
Fixed Overhead	$414,375 (42500*9.75)	$276,250 (414,375*2/3)
Price offered by supplier (42500*25.75)		$1,094,375 (42500*25.75)
Rental Income (opportunity )		-$94,000
Total Cost	$1,232,500	$1,276,625

Total Cost under accepting offer is coming $1,276,625 it is higher than the cost of making the product by using facility.

If offer is accepted, disadvantage of accepting offer is $44,125.

The profit of the company will be decreased by $44,125

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