Question

Frosty's Farming Company purchases 52,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $8.25 per unit. The company now has idle capacity that could be used to produce starters rather than buying from an outside supplier, but the chief engineer is concerned because the production cost per unit is $9.15 as shown below: Per Unit Total Direct materials 3.30 Direct labor 2.50 Supervision 1.60 83,200.00 Depreciation 0.90 46,800.00 Variable manufacturing overhead 0.55 Rent 0.30 15,600.00 Total productions cost 9.15 If Frosty's makes the starters, a supervisor would have to be hired (at a salary of $83,200) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on the space utilized in the plant. The total rent on the plant is $90,000 per period. Depreciation is due to obsolescence rather than wear and tear. ----------------------------------------------------

1. Of the $9.15 production cost per unit shown above, what is the total per unit cost that is not relevant to the make decision? (in other words, the cost would still be there whether the company chooses to make or buy)
2. What would be the total differential cost to Make the 52,000 starters?
3. What would be the total differential cost to Buy the 52,000 starters?
4. What is the financial advantage (disadvantage) to making the starters instead of buying from a supplier?

Answer 1

The total per unit cost not relevant in the make-or-buy decision for Frosty's Farming Company is $1.20 per unit. Making the starters results in a total differential cost of $413,400, while buying them incurs a cost of $429,000, leading to a financial advantage of $15,600 for making the starters in-house.

Step-by-step explanation:

The question asks about the relevance of different costs in a make-or-buy decision and the financial advantage of either option for Frosty's Farming Company.

1. The total per unit cost not relevant to the make decision includes rent and depreciation because these costs will be incurred regardless of whether Frosty's decides to make or buy the starters. The total not relevant cost per unit is the sum of depreciation ($0.90) and rent ($0.30), which equals $1.20 per unit ($0.90 + $0.30).

2. The total differential cost to Make the 52,000 starters is the production cost per unit minus the irrelevant costs, multiplied by the quantity: ($9.15 - $1.20) × 52,000 = $7.95 × 52,000 = $413,400.

3. The total differential cost to Buy the 52,000 starters is simply the price per unit multiplied by the quantity: $8.25 × 52,000 = $429,000.

4. The financial advantage (disadvantage) to making the starters instead of buying is the difference between the differential cost to buy and the differential cost to make: $429,000 - $413,400 = $15,600. Thus, making the starters saves the company $15,600.