Question

The SP Corporation makes 40,000 motors to be used in the production of its sewing machines. The average cost per motor at this level of activity is:

Direct materials	$	9.90
Direct labor	$	8.90
Variable manufacturing overhead	$	3.65
Fixed manufacturing overhead	$	4.60

An outside supplier recently began producing a comparable motor that could be used in the sewing machine. The price offered to SP Corporation for this motor is $25.15. If SP Corporation decides not to make the motors, there would be no other use for the production facilities and none of the fixed manufacturing overhead cost could be avoided. Direct labor is a variable cost in this company. The annual financial advantage (disadvantage) for the company as a result of making the motors rather than buying them from the outside supplier would be:

Multiple Choice

($76,000)

$254,000

108,000

$184,000

Answer 1

Case1: Company is making the machines:

Direct materials $9.90

Direct labor $8.90

Variable manufacturing overhead $3.65

Fixed manufacturing overhead $4.60

Total Cost $27.05

Total Cost for 40000 machines 40000*$27.05

Case2: Company decides to buy from outside:

Price offered $25.15

As none of the fixed manufacturing overhead cost could be avoided, company would still be incurring fixed cost of $4.6 per unit

Total Cost = $29.75

Total cost for 40000 machines $29.75 * 40000

Hence, the company would be saving $2.7 per unit if they decide to make it.

For 40000 machine : $2.7 * 40000 = $108000 Answer

Hence the company would be saving $108000 on 40000 machines if they decide to make the same.

3rd option is correct

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