Question

Curly Inc. is considering whether to continue to make a component or to buy it from an outside supplier. The company uses 16,000 of the components each year. The unit product cost of the component according to the company's cost accounting system is given as follows: Assume that direct labor is a variable cost. Of the fixed manufacturing overhead, 30% is avoidable if the component were bought from the outside supplier. In addition, making the component uses 1 minute on the machine that is the company's current constraint. If the component were bought, this machine time would be freed up for use on another product that requires 2 minutes on the constraining machine and that has a contribution margin of $8.10 per unit. When deciding whether to make or buy the component, what is the maximum price the company would pay if it decides to buy?

Answer 1

the maximum price the company can pay for the component is $24.65

Step-by-step explanation:

• direct materials: $8.10 per unit
• direct labor: $6.40 per unit
• variable manufacturing overhead: $1.70 per unit
• fixed manufacturing overhead: $4.40 per unit
• total variable costs: $20.60 per unit

Current total manufacturing costs for 16,000 units = $20.60 x 16,000 units = $329,600

if the component is bought, 30% of fixed costs can be avoided = $4.40 x 16,000 x 30% = $21,120 or $1.32

or the machine can be used to manufacture another product that has a contribution margin of $8.10 per unit and a total production of 8,000 units = $8.10 x 8,000 = $64,800 or $4.05 per unit

by purchasing the component from a vendor, the company will save either $1.32 or $4.05 per unit

therefore the company should purchase the component if its maximum price is = $20.60 + $4.05 = $24.65