Question

1. Gordon Corporation produces 1,000 units of a part per year which are used in the assembly of one of its products. The unit cost of producing these parts is:

Variable manufacturing cost	$	15
Fixed manufacturing cost		12
Total manufacturing cost	$	27

The part can be purchased from an outside supplier at $20 per unit. If the part is purchased from the outside supplier, two thirds of the total fixed costs incurred in producing the part can be avoided. The annual financial advantage (disadvantage) for the company as a result of buying the part from the outside supplier would be:

2.

Joetz Corporation has gathered the following data on a proposed investment project (Ignore income taxes.):

Investment required in equipment	$	30,000
Annual cash inflows	$	6,000
Salvage value of equipment	$	0
Life of the investment		15	years
Required rate of return		10	%

The company uses straight-line depreciation on all equipment. Assume cash flows occur uniformly throughout a year except for the initial investment.

The payback period for the investment is:

Answer 1

	Making	Purchasing
Variable cost	$15	-
Add: Fixed cost	$12	*$4
Add: Purchasing cost	-	$20
Total cost per unit	$27	$24
Total cost for 1,000 units	$27,000	$24,000

*$ 4 = $ 12 x 1/3   as 2/3 of fixed cost is avoidable.

Financial advantage = Making cost – Purchasing cost = $ 27,000 - $ 24,000 = $ 3,000

The annual financial advantage for the company on buying the parts from outside supplier would be $ 3,000.

2.

Formula for payback period of a project with even cash flow is:

Payback period = Investment required/Net Annual Cash Flow

                       = $ 30,000/$ 6,000 = 5 years

Payback period for the investment is 5 years.