Question

X Company is considering buying a part next year that it currently makes. A company has offered to supply this part for $16.06 per unit. This year's total production costs for 50,000 units were:

Materials	$250,000
Direct labor	280,000
Total overhead	270,000

$190,000 of X Company's total overhead costs were variable; $22,400 of X Company's fixed overhead costs can be avoided if it buys the part. If X Company buys the part, there are no alternative uses of the resources that were used for its production. Production next year is expected to increase to 53,300 units.

3. If X Company continues to make the part instead of buying it, it will save

4. X Company has an opportunity to negotiate the purchase price with the supplier. What purchase price would make X Company indifferent between making and buying?

Answer 1

Alt 1) Purchase the part

cost = 16.06 per unit * 53300 units = 855998

Alt 2 ) Make the part

Cost = [(Material + labour + variable OH)/no of units this year *No of units in next yr] + Avoidable Fixed OH

= [(250000+280000+190000)/50000*53300] + 22400 = 789920

If it make the part it will save = 855998 - 789920 =66078

It will negotiate price so that cost of making could be atleast equal to making it

Cost of buying should not be more than = 789920/53300 = 14.820