Question

ABCD Company manufactures Part 4A in one of its products. This unit cost of this part is

	Per Unit
Direct materials	$ 3.75
Direct labor	$ 7.75
Variable manufacturing overhead	$ 8.00
Supervisor's salary	$ 3.50
Depreciation of special equipment	$ 2.00
Allocated general overhead	$ 3.00
Unit product cost	$ 28.00

A total of 10,000 units of this part are produced and used every year. An outside supplier has offered to make the part and sell it to the ABCD Company for $26.00 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including the direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company, none of which would be avoided if the part were purchased instead of produced internally. In addition, the space used to make part 4A could be leased to others by $ 2,500 per year.

a) What is the annual financial advantage (disadvantage) for the company as a result of buying part 4A from the outside supplier?

b) Should the outside supplier’s offer be accepted? Why?

Answer 1

	Per unit		Total 10000 units
	Make	Buy	Make	Buy
Direct materials	3.75		37500
Direct labor	7.75		77500
Variable manufacturing overhead	8.00		80000
Supervisor's salary	3.50		35000
Opportunity cost			2500
Purchase cost		26.00		260000
Total			232500	260000
a
Difference in favor of making = 232500-260000 = $27500
Financial (disadvantage) (27500)

b

No, Reject the outside supplier’s offer

If the outside supplier’s offer is accepted, the income would decrease by $27500