Question

QUESTION 4

Make or Buy a Component

Current-Control, Inc., manufactures a variety of electrical switches. The company is currently manufacturing all of its own component parts. An outside supplier has offered to sell a switch to Current- Control for $32 per unit. To evaluate this offer, Current-Control, Inc., has gathered the following information relating to its own cost of producing the switch internally:

Per 12,000 Units

Unit per Year

Direct materials                                                            $12               $144,000

Direct labour                                                                 10                 120,000

Variable manufacturing overhead                                   3                    36,000

Fixed manufacturing overhead, traceable                         8*                   96,000

Fixed manufacturing overhead, common, but allocated 16             192,000

Total cost                                                                      $49               $588,000

*25% supervisory salaries; 75% depreciation of special equipment (no resale value).

Required:

1. Assuming that the company has no alternative use for the facilities now being used to produce the switch, should the outside supplier's offer be accepted? Show all computations.
2. Suppose that if the switches were purchased, Current-Control, Inc., could use the freed capacity to launch a new product. The segment margin of the new product would be $78,000 per year. Should Current-Control, Inc., accept the offer to buy the switches from the outside supplier for $32 each? Show computations.

Answer 1

Ans:

1.

In case free capacity has no other use, variable cost per unit will be relevant to consider the decision.

Variable costs :

Direct Material : $12

Direct Labor : $10

Variable over head : $3

Variable cost per unit : $12 + $10 + $3 = $25

Outside supplier offer : $32

So current control Inc. should produce the switch.

2.

If Company can use the capacity to generate $78,000 from Free capacity.

Addition cost of Purchase 12,000 Switches

= ($32-$25)*12,000 = $84,000

Incremental Loss : $84,000 - $78,000 = ($6,000)

So current control Inc. should produce the switch in this case also.

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