Question

QUESTION 5                                                              20 marks

Junior Company currently buys 30,000 units of a part used to manufacture its product at R40 per unit. Recently the supplier informed Junior Company that a 20% increase will take effect next year. Junior has some additional space and could produce the units for the following per-unit costs (based on 30,000 units):

Direct materials                       R16

Direct labour                              12

Variable overhead                      12

Fixed overhead                          10

Total                                        R50

If the units are purchased from the supplier, R200,000 of fixed costs will continue to be incurred. In addition, the plant can be rented out for R20,000 per year if the parts are purchased externally.

Required:

Should Junior Company buy the part externally or make it internally?

Answer 1

Produce internally; it saves $120,000. ($1,620,000 - $1,500,000)
If purchased externally:
Purchase price (30,000 x 40 x 1.20)	1,440,000
Add: Fixed costs	200,000
Less: Rent received	(20,000)
Net cost to purchase	1,620,000
If produced internally:
Cost to produce (30,000 x $50)	1,500,000