Question

Han Products manufactures 30,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is:

Direct materials	$	3.60
Direct labor		10.00
Variable manufacturing overhead		2.40
Fixed manufacturing overhead		9.00
Total cost per part	$	25.00

An outside supplier has offered to sell 30,000 units of part S-6 each year to Han Products for $21 per part. If Han Products accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental of $80,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier.

Required:

What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?

Answer 1

	Make (per unit)	Buy (per unit)	Make	Buy
Cost of purchasing		$21.00		$630,000
Cost of making:
..Direct materials	$3.60		$108,000
..Direct labor	$10.00		$300,000
..Variable overhead	$2.40		$72,000
..Fixed Overhead ($9.00 * 1/3)	$3.00	$	$90,000
Total Cost	$19.00	$21.00	$570,000	$630,000
Add: Opportunity Cost (Annual rent)			$80,000
Total cost ( including Opportunity Cost )			$650,000	$630,000

Financial advantage of accepting the outside supplier’s offer is $20,000 ($650,000 - $630,000).

Wrking Notes:

Two-third fixed cost is same in both cases.