Question

Futura Company purchases the 78,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $11.90 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $12.40 as shown below:

	Per Unit			Total
Direct materials	$	5.00
Direct labor		3.20
Supervision		1.70		$	132,600
Depreciation		1.20		$	93,600
Variable manufacturing overhead		0.70
Rent		0.60		$	46,800
Total product cost	$	12.40

If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $132,600) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $89,000 per period. Depreciation is due to obsolescence rather than wear and tear.

Required:

What is the financial advantage (disadvantage) of making the 78,000 starters instead of buying them from an outside supplier?

Answer 1

Answer:- The financial advantage of making the 78,000 starters instead of buying them from an outside supplier is $101400.

Explanation:-Cost of making is lower than cost of buying, hence the financial advantages of making the 78000 starters is $101400 (ie-$11.90-$10.60)*78000 starters.

The rent expenses and depreciation are part of the unavoidable cost, they are always incurred whether the starter are manufactured or purchased, hence ignored them for decision making process.

Futura Company
Statement of Comparative cost
Manufacturing	Amount	Purchase from outside Supplier	Amount
Alternative 1	Per unit $	Alternative 2	Per unit $
Direct Material	5.00	Purchase Cost	11.90
Direct Labor	3.20
Variable Manufacturing Overhead	0.70
Supervision	1.70
Total Manufacturing cost	10.60	Total Purchase cost	11.90