Question

Howell Corporation produces an executive jet for which it currently manufactures a fuel valve; the cost of the valve is indicated below: Cost per Unit Variable costs Direct material $900 Direct labor 600 Variable overhead 300 Fixed costs Depreciation of equipment 500 Depreciation of building 225 Supervisory salaries 300 The company has an offer from Duvall Valves to produce the part for $2,000 per unit and supply 1,000 valves (the number needed in the coming year). If the company accepts this offer and shuts down production of valves, production workers and supervisors will be reassigned to other areas. The equipment cannot be used elsewhere in the company, and it has no market value. However, the space occupied by the production of the valve can be used by another production group that is currently leasing space for $55,000 per year. What is the incremental savings of buying the valves? (The answer should be stated in a per-unit format and is a positive number) Round to two decimal places. Your Answer:

Answer 1

	Howell Corporation
	Variable Cost
	Direct Material	$           900.00
	Direct Labor	$           600.00
	Variable Overhead	$           300.00
	Fixed Cost
	Depreciation of Equipment	$           500.00
	Depreciation of building	$           225.00
	Supervisory Salary	$           300.00
	Offer for buying 1000 Valves @$2000 per unit
	Incremental cost to buy(1000*$2000)=(A)		$ 20,00,000.00
	Cost saving
	Raw Material(1000*$900)	$ 9,00,000.00
	Direct Labor(1000*$600)	$ 6,00,000.00
	Variable Overhead(1000*$300)	$ 3,00,000.00
	Leased Space saving	$     55,000.00
	Supervisory Salaries(1000*$300)	$ 3,00,000.00	$ 21,55,000.00
	Cost saving =(B)
	Incremental saving if buy decision is made(B)-(A)		$    1,55,000.00
	Relevant cost: Direct Material,Direct Labor and variable cost can be avoided if purchased
	from outside.
	Lease Space is also relevant because it can be used for another production group.
	Supervisory cost is relevant because production workers and supervisors could be
	assigned to another areas.
	Depreciation of Equipment and building is a sunk cost , which cannot be avoided
	when purchased from outside.