Question

For many years Futura Company has purchased the starters that it installs in its standard line of farm tractors. Due to a reduction in output, the company has idle capacity that could be used to produce the starters. The chief engineer has recommended against this move, however, pointing out that the per unit cost to produce the 40,000 starters needed would be greater than the current $8.40 per unit purchase price:

	Per Unit		Total
Direct materials	$	3.10
Direct labor		2.70
Supervision		1.50	$	60,000
Depreciation		1.00	$	40,000
Variable manufacturing overhead		0.60
Rent		0.30	$	12,000
Total product cost	$	9.20

A supervisor would have to be hired to oversee production of the starters. However, the company has sufficient idle tools and machinery so that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $80,000 per period. Depreciation is due to obsolescence rather than wear and tear.

Required:

1.	Determine the total relevant cost per unit if starters are made inside the company. (Round your answer to 2 decimal places.)

   

2.	Determine the total relevant cost per unit if starters are purchased. (Round your answer to 2 decimal places.)

   

3.	What is the increase or decrease in profits as a results of purchasing the parts from the starters rather than making them inside the company? (Do not round intermediate calculations.)

    

Answer 1

1. Relevant cost for the starters made in house would be $7.90 per unit.

Let’s analyze the cost involved in it:

• Direct Material per unit: $3.10 (relevant)
• Direct labor per unit - $2.7 (relevant)
• Supervision- $60,000 (relevant cost for production of starters)- $1.5 per unit
• Depreciation- Irrelevant cost since it will be incurred if starters are made-in house.
• Variable Manufacturing Overhead- $0.6 (relevant)
• Rent $12,000 is the allocation. Since it will be incurred even if starters are made in house, it will become irrelevant cost for production.

Relevant cost per unit= $3.1 + $2.7 + $1.5 + $0.6= $7.90

1. Purchase price per unit for Starter= $8.40 which is the relevant cost in case of Buy Option.

1. Decrease in profit if bought from Outside would be $20,000

Differential Price= $8.40- $7.90= $0.50

No. of starters to be purchased= 40,000

Total price to be paid extra= $40,000 * 0.5= $20,000.