Question

# Diehl Corporation manufactures a variety of parts for use in its product. The company has always...

Diehl Corporation manufactures a variety of parts for use in its product. The company has always produced all of the necessary parts for its product, including all of the electronic circuits. The company sells 20,000 units of its product per year. An outside supplier has offered to sell electronic circuits to the company for a cost of \$36 per unit. To evaluate this offer, the company has gathered the following information relating to its own cost of producing the electronic circuits internally:

 Per Unit 20,000 Units per Year Direct materials \$ 13 \$ 260,000 Direct labor 11 220,000 Variable manufacturing overhead 4 80,000 Fixed manufacturing overhead, traceable 6 * 120,000 Fixed manufacturing overhead, allocated 9 180,000 Total cost \$ 43 \$ 860,000

*One-third supervisory salary; two-thirds depreciation of special equipment (no resale value).

Suppose that if the electronic circuits were purchased, the division supervisor position could be eliminated. Fixed manufacturing overhead will be allocated to other products made by the company. Also, the company could use the freed production capacity to launch a new product. The segment margin of the new product would be \$200,000 per year. Given this new assumption, how much would be the financial advantage of buying 20,000 electronic circuits from the outside supplier?

Ans:

Cost of Purchase : 20,000 Units @\$36 each

= 20,000 * \$36 = \$720,000

Cost savings if Purchased from outside :

Direct Material : 20,000 * \$13 = \$260,000

Direct Labor : 20,000 * \$11 = \$220,000

Variable Manufacturing Overhead : 20,000 * \$4 = \$80,000

Saving in supervisory salary : 20,000 *1/3 *\$6 = \$40,000

Additional Contribution margin of new product : \$200,000

Total Savings : \$260,000 + \$220,000 + \$80,000 + \$40,000 + \$200,000 = \$800,000

So Net Savings will be = \$800,000 - \$720,000 = \$80,000

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