Question

X Company is considering buying a part next year that they currently make. This year's per-unit production costs for 3,400 units were:

Materials	$2.56
Direct labor [all variable]	3.65
Variable overhead	3.60
Fixed overhead	3.40
Total production costs	$13.21

A company has offered to supply this part for $12.17 per unit. If X Company buys the part, $5,780 of the fixed overhead can be avoided. Also if X Company buys the part, it can use the freed-up resources to increase production of another product, resulting in additional contribution margin of $2,400. Production next year is also expected to be 3,400 units.

2. If X Company buys the part instead of making it, it will save ?

3. At what production level would X Company be indifferent between making and buying the part?

Answer 1

Solution 2:

Differential Analysis - Making Parts (alt 1) or Buying Parts (Alt2) - X Company
Particulars	Making Parts (Alt 1)	Buying Parts (Alt 2)	Financial advantage (Disadvantage) of buying (Alternative 2)
Costs:
Purchase Price (3400*$12.17)	$0.00	$41,378.00	-$41,378.00
Direct material	$8,704.00	$0.00	$8,704.00
Direct Labor	$12,410.00	$0.00	$12,410.00
Variable overhead	$12,240.00	$0.00	$12,240.00
Avoidable Fixed Manufacturing cost	$5,780.00	$0.00	$5,780.00
Opportunity cost of increase production of other product	$2,400.00		$2,400.00
Total Cost	$41,534.00	$41,378.00	$156.00

Yes, company will save on buying the parts and net annual saving = $156.

Solution 3:

Variable cost per unit of manufacturing = $2.56 + $3.65 + $3.60 = $9.81

Buying cost per unit = $12.17

Difference in variable cost = $12.17 - $9.81 = $2.36

Total fixed and opportunity cost saving on buying = $5,780 + $2,400 = $8,180

Production level at which X company be indifferent between making and buying the part = $8,180 / $2.36 = 3466 units