Question

Question 4 40 marks The management of James Industries has been evaluating whether the company should continue manufacturing a component or buy it from an outside supplier. A R200 cost per component has been determined as follows: R Direct materials 15 Direct labour 40 Variable manufacturing overhead 10 Fixed manufacturing overhead 35 Total 100 James Industries uses 4000 components per year. After Light SA has submitted a bid of R80 per component, some members of management feet they could reduce costs by buying from outside and discontinuing production of the component. If the component is obtained from Light SA, James's unused production facilities could be leased to another company for R50 000 per year Required: a. Determine the maximum amount per unit James should pay an outside supplier. b. Indicate whether the company should make or buy the component and the total monetary difference in favour of that alternative. c. Assume the company could eliminate production supervisors with salaries totalling R30 000 if the component were purchased from an outside supplier. Indicate whether the company should make or buy the component and the total monetary difference in favour of that alternative.

Answer 1

a)Since fixed manufacturing overhead cost will be incurred whether purchased from outside supplier or manufactured internally thus it is irrelevant cost .

Savings if purchased
Direct material	15
Direct labor	40
variable overhead	10
revenue from lease of unused facility[50000/4000]	12.5
Maximum price per unit James should pay an outside supplier (amount of saving)	77.5

2)The company should make the component since there is an advantage of [80-77.5]*4000= 10000 if manufactured internally

3)

Savings
Total savings if purchased from outside suppliers [77.5*4000]+30000	340000
less:cost to purchase [80*4000]	(320000)
Incremental savings	20000

Since there is an incremental savings of $ 20000 if purchased from outside suppliers, component should be purchased.