Question

# Royal Company manufactures 20,000 units of part R-3 each year for use on its production line....

Royal Company manufactures 20,000 units of part R-3 each year for use on its production line. At this level of activity, the cost per unit for part R-3 is:

Direct Materials ……………………... \$ 4.80

Direct labor ………………………………… 7.00

Total cost per part…………………………….. \$25.00

An outside supplier has offered to sell 20,000 units of part R-3 each year to Royal Company for \$23.50 per part. If Royal Company accepts this offer, the facilities now being used to manufacture part R-3 could be rented to another company at an annual rental of \$150,000. However, Royal Company has determined that \$6 of the fixed manufacturing overhead being applied to part R-3 would continue even if part R-3 were purchased from the outside supplier.

Required:

Prepare computations showing how much profits will increase or decrease if the outside supplier's offer is accepted.

The profit will increase by \$ 60000 if outside supplier offer is accepted.

 Incremental savings if purchased Direct material (4.8*20000) 96000 Direct labor (7*20000) 140000 Variable overhead (3.2*20000) 64000 Fixed overhead (4*20000) 80000 Rental income 150000 Total savings 530000 Incremental cost if purchased Purchase cost (20000*23.50) (470000) Advantage /(disadvantage) if purchased 60000

#Out of fixed overhead ,\$ 6 will be incurred even if purchased thus saving in fixed cost per unit if purchased = 10 -6 = \$ 4

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