Question

D Co's entire machine capacity is used to produce essential components. The variable costs of using the machines are $150,000 and the fixed costs are $400,000. If all the components were purchased from an outside supplier, the machines could be used to produce other items which would earn a total contribution of $250,000.

Answer 1

The company should not be willing to pay more than $300,000 to the outside supplier for the components

Currently, the total cost of producing the components in-house includes variable costs and fixed costs, which add up to:

= $150,000 + $400,000

= $550,000

This is the cost the company incurs to produce the components using its machines.

On the other hand, if the company opts to buy the components from an outside supplier, it frees up its machines, allowing it to produce other items. This alternative use of the machines would generate a contribution of $250,000.

The cost of purchasing the components must be equal to the total cost of producing them in-house minus the opportunity cost of not using the machines for other production.

So, the maximum price the company should be willing to pay the outside supplier is calculated as follows:

Total Production Cost - Opportunity Cost = $550,000 - $250,000

= $300,000

The question is:

What is the maximum price that a profit- maximising company should be willing to pay to the outside supplier for the components