Question

Waiters, Inc. has been manufacturing 10,000 units of part 2050 per month, which is used in manufacturing one of its products. At this level of production, the cost per unit to manufacture part 2050 follows:

                               Direct materials           $10.00

                               Direct labor                    25.00

                               Variable overhead          13.00

                               Fixed overhead               12.00

                               Total                              $60.00

Westbrook Company has offered the sell Waiters 10,000 units of part 2050 for $55 a unit. Waiters has determined that it could use the facilities presently used to manufacture part 2050 to manufacture produce RAC, which would generate an additional contribution margin per month of $50,000. Waiters also has determined that one-third of the fixed overhead will be incurred even if it purchases part 2050 from Westbrook and makes product RAC.

Required:

Determine whether or not Waiters should purchase from Westbrook. Assume that Waiters would take the opportunity to make product RAC.

Answer 1

Direct materials           $10.00

Direct labor                    25.00

Variable overhead          13.00

Variable cost per unit of part 2050 = $48

Fixed overhead per unit of part 2050 = $12

Monthly production of part 2050 = 10,000 units

Hence, monthly total fixed overheads = 10,000 x 12

= $120,000

Westbrook Company has offered the sell Waiters 10,000 units of part 2050 for $55 a unit.

Westbrook company's price is $7 per unit more than variable cost of production. Waiters has determined that it could use the facilities presently used to manufacture part 2050 to manufacture produce RAC, which would generate an additional contribution margin per month of $50,000. Waiters also has determined that one-third of the fixed overhead (120,000 x 1/3 = $40,000) will be incurred even if it purchases part 2050 from Westbrook and makes product RAC.

Hence, reduction in monthly fixed overheads if part 2050 is purchased from Westbrook = 120,000 - 40,000

= $80,000

Financial impact of purchasing part 2050 from Westbrook

Additional contribution margin earned by producing RAC	50,000
Reduction in fixed overheads	80,000
Additional cost of buying from Westbrook (10,000 x 7)	- 70,000
Incremental benefit derived from buying from Westbrook	$60,000

Hence, Waiters should purchase from Westbrook since it will provide additional income of $60,000.