Question

HD Corporation manufactures vehicles parts. When its production facilities are fully utilized it uses external sub-contractors to complete some orders. Management is reconsidering the uses of its manufacturing facilities for the coming year. The following table details the cost of producing a motor called the WB 13 used in the cooling system.

Total cost for 60,000 units

Direct Materials $ 480,000

Direct Labour 360,000

Variable production overheads 180,000

Fixed production overheads 360,000

Total manufacturing cost $1,380,000

One of the external producers has offered to supply HD Corporation with the same part for $ 21 each. If the part is purchased externally; related fixed cost to the production of this part of $ 120,000 will be avoided.

Required:

a. What is the relevant per unit cost for the original part it assumed that the capacity now used to manufacture this part will become idle and should the part be made or bought?

b. Assume that the capacity now being used to manufacture this part can be either (a) rented to earn $ 75,000 per quarter or (b) be used to make oil filters that will yield a profit contribution of $ 240,000 for the year. What is the best decision for HD Corporation management to propose?

Answer 1

Relevant cost per unit:
Material cost (480000/60,000)		8
Direct labour cost (360000/60000)	6
Variable Production OH (180000/60000)	3
Avoided Fixedd cost(120000/60000)	2
Relevant cost per unit:		19
Differential analysis
			Make	Buy	Effect on Income
Material cost		480000	0	480000
Labour cost		360000	0	360000
variable overheads		180000	0	180000
fixed overheads		360000	240000	120000
Opportunity cost (300,000+240000)	540000	0	540000
Cost of purchase (60000*21)	0	1260000	-1260000
Total cost			19,20,000	15,00,000	420000
Net financial advantage of buying the parts: $ 420,000
Hence, the product shall be purchased