Question

Kramer Company makes 4,600 units per year of a part called an axial tap for use in one of its products. Data concerning the unit production costs of the axial tap follow:

    

Direct materials		$	41
Direct labor			16
Variable manufacturing overhead			14
Fixed manufacturing overhead			20
Total manufacturing cost per unit		$	91

      

An outside supplier has offered to sell Kramer Company all of the axial taps it requires. If Kramer Company decided to discontinue making the axial taps, 40% of the above fixed manufacturing overhead costs could be avoided. Assume that direct labor is a variable cost.

    

Required:

a1.	Assume Kramer Company has no alternative use for the facilities presently devoted to production of the axial taps. If the outside supplier offers to sell the axial taps for $89 each, calculate the total cost for making the axial taps.

       

Total cost

$

    

a2.	Should Kramer Company accept the offer?
	Yes No

    

b.

Assume that Kramer Company could use the facilities presently devoted to production of the axial taps to expand production of another product that would yield an additional contribution margin of $92,000 annually. What is the maximum price Kramer Company should be willing to pay the outside supplier for axial taps?

Maximum acceptable price

$

Answer 1

Solution:-

(a1)

        Variable Cost of manufacturing 1 axial tap :-

Direct materials	41
Direct labor	16
Variable manufacturing overhead	14
Fixed manufacturing overhead (20*40%)	8
Total variable cost	79

Purchase Price from Outside supplier = 89

(a2) The company should not accept the offer due to following:-

                Benefit in manufacture over purchase = 89-79 = 10

(b) Maximum price Kramer Company should be willing to pay the outside supplier for axial taps:-

      Manufacturing variable cost of 4600 units (4600*79) = 363400

     Opportunity cost of another product (additional contribution) =        92000

    Maximum price to outsider = (363400+92000)/4600 = 99