Question

Kirsten Corporation makes 100,000 units per year of a part called a B345 gasket for use in one of its products. Data concerning the unit production costs of the B345 gasket follow:

direct materials .... 0.15

direct labor .... 0.10

variable manufacturing overhead ..... 0.13

fixed manufacturing overhead .... 0.24

total manufacturing cost per unit .... 0.62

An outside supplier has offered to sell Kirsten Corporation all of the B345 gaskets it requires. If Kirsten Corporation decided to discontinue making the B345 gaskets, 25% of the above fixed manufacturing overhead costs could be avoided.

Required:

Assume Kirsten Corporation has no alternative use for the facilities presently devoted to production of the B345 gaskets. If the outside supplier offers to sell the gaskets for $0.45 each, should Kirsten Corporation accept the offer? Fully support your answer with appropriate calculations direct

Assume that Kirsten Corporation could use the facilities presently devoted to production of B345 gaskets to expand production of another product that would yield an additional contribution margin of $10,000 annually. What is the maximum unit price Kirsten Corporation should be willing to pay the outside supplier for the B345 gasket ?

Answer 1

Fixed manufacturing Overheads = 100,000 units @ 0.24 i.e. $24,000

Avoidable fixed costs = 25% of total fixed manufacturing overheads

= $6,000

Variable cost per unit = $0.38 ($0.15 + $0.10 + $0.13)

(a) Analysis of the Outsider Supplier

Cost of Purchasing from outside Supplier : (100,000 units @ $0.45) : $45,000

Less: Savings in costs : [(100,000 units @ $0.38) + $6000] : ($44,000)

Excess cost in purchasing from outside supplier : $1,000

(b)

Savings from outside supplier's offer

Savings in cost : [(100,000 units @ $0.38) + $6000] : $44,000

Add: Additional contribution margin from facility : $10,000

Total savings : $54,000

Kirsten Corporation will be willing to pay per unit to supplier maximum up to the benefit from closing of the facility.

Maximum price per unit = Total Saving / Number of units

= $54,000 / 100,000 units

= $0.54 per unit