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 65,000 starters needed would be greater than the current $11.00 per unit purchase price:

	Per Unit		Total
Direct materials	$	5.00
Direct labor		2.80
Supervision		1.50	$	97,500
Depreciation		1.40	$	91,000
Variable manufacturing overhead		0.50
Rent		0.40	$	26,000
Total product cost	$	11.60

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 $86,000 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 from an outside supplier. (Round your answer to 2 decimal places.)

       

3.	What is the increase or decrease in profits as a result of purchasing the starters from an outside supplier rather than making them inside the company? (Do not round intermediate calculations. Round your answer to the nearest dollar amount.)

      

Answer 1

Solution-

1) Computation of total relevant cost per unit ,if starters are made inside the company -

Direct Materials	$5.00
Direct Labor	2.80
Supervision	1.50
Variable manufacturing overhead	0.50
Total relevant cost per unit	$9.80

Ans : Relevent cost per unit = $9.80

2) If starters are purchased from an outside supplier , then total relevant cost per unit will be $11.00

Ans : Relevant cost per unit = $11.00

3)

Cost of purchasing [65000 * $11.00]	$715000
Cost of manufacturing [65000 * $9.80]	$637000
Net financial disadvantage	$78000

So, profits will be decreased by $78000 , if the starters are purchasing from an outside supplier rather than making them inside the company.

Ans : Profit would decrease by $78000 .