Question

ABC Company makes 40,000 units per year of a part it uses in the

products it manufactures. The per unit product cost of this part

is shown below:

direct materials .............. $15.30

direct labor .................. 24.70

variable overhead ............. 2.10

fixed overhead ................ 27.40

total ......................... $69.50

An outside supplier has offered to sell ABC Company 40,000 units

of this part a year for $66.10 per unit. If ABC Company accepts

this offer, the facilities now being used to make this part could

be used to make more units of a product that is in high demand.

The additional contribution margin that could be earned on this

other product would be $100,000 per year.

If ABC Company accepts the outside supplier's offer, $21.90 of the

fixed overhead cost being applied to the part would be eliminated.

The remaining amount would continue to be incurred and would be

allocated to the company's remaining products.

Calculate the selling price per unit charged by the outside

supplier that would make ABC Company economically indifferent

between making and buying the part.

Answer 1

Avoidable Cost: Avoidable costs are the cost that can be saved due to discontinuation of a product line.

In the given case Avoidable cost is as follows:

Direct Material	15
Direct Labor	25
Variable overhead	2
Fixed Overhead (27.40-21.90)	6
Total Cost per unit	48
Total Units	40,000
Avoidable Costs	19,04,000

Opportunity Cost: Opportunity cost is the amount of benefit foregone by not choosing the other alternatives.

In the given case Opportunity cost is $100,000

As per the Make or Buy Decision rules, the ABC Company should Make or Buy based on the following situation:

Avoidable Costs + Opportunity Costs > Outside Purchase Price = Buy

Avoidable Costs + Opportunity Costs < Outside Purchase Price = Make

At the Indifference Point, the make or buy decisions are equal. Hence, the selling price per unit charged by the outside supplier as follows

Let 'N' be the Selling price per unit charged by the outside supplier

Avoidable Costs + Opportunity Costs = Outside Purchase Price

$1,904,000 + $100,000 = 40,000 units * N

N = $ 50.10 per unit.