Question

Foto Company makes 14,000 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows:

Direct materials	$	13.60
Direct labor		21.20
Variable manufacturing overhead		3.40
Fixed manufacturing overhead		11.30
Unit product cost	$	49.50

An outside supplier has offered to sell the company all of these parts it needs for $42.70 a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be $32,200 per year.

If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, $6.00 of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the company's remaining products.

Required:

a. How much of the unit product cost of $49.50 is relevant in the decision of whether to make or buy the part? (Round "Per Unit" to 2 decimal places.)

b. What is the financial advantage (disadvantage) of purchasing the part rather than making it?

Answer 1

Solution a:

Unit product cost that relevant in decesion of whether to make or buy part are those cost which can be avoided by the company if company buy the parts.

Therefore unit product cost relevant for decesion making = Direct material + Direct labor + Variable manufacturing overhead + Avoidable fixed manufacturing overhead

= $13.60 + $21.20 + $3.40 + $5.30 (Avoidable fixed manufacturing cost) = $43.50 per unit

Solution b:

Differential Analysis - Making Part (alt 1) or Buying Part (Alt2)
Particulars	Making Part Case (Alt 1)	Buying Part (Alt 2)	Financial advantage (Disadvantage) of buying (Alternative 2)
Costs:
Purchase Price (18000*$42.70)	$0.00	$597,800.00	-$597,800.00
Direct material	$190,400.00	$0.00	$190,400.00
Direct Labor	$296,800.00	$0.00	$296,800.00
Variable overhead	$47,600.00	$0.00	$47,600.00
Avoidable Fixed Overhead	$74,200.00	$0.00	$74,200.00
Loss of opportunity of new product margin	$32,200.00	$0.00	$32,200.00
Income / (Loss)	$641,200.00	$597,800.00	$43,400.00

Net financial advantage of purchasing the part is $43,400