Question

Company makes and sells lawn mowers for which it currently makes the engines. It has an opportunity to purchase the engines from a reliable manufacturer. The annual costs of making the engines are shown here.

Cost of materials (20,000 units × $26): $ 520,000
Labor (20,000 units × $20): 400,000
Depreciation on manufacturing equipment*: 42,000
Salary of supervisor of engine production: 85,000
Rental cost of equipment used to make engines: 23,000
Allocated portion of corporate-level facility-sustaining costs: 80,000
Total cost to make 20,000 engines: $ 1,150,000

The equipment has a book value of $90,000 but its market value is zero.


Determine the maximum price per unit that Levesque would be willing to pay for the engines.
Determine the maximum price per unit that Levesque would be willing to pay for the engines, if production increased to 24,000 units.

Answer 1

The maximum price per unit Levesque can pay for the engines is $47.15 when producing 20,000 units and $39.29 for 24,000 units, considering only the relevant costs.

Step-by-step explanation:

To determine the maximum price per unit Levesque would be willing to pay for the engines, one should consider only the relevant costs. Relevant costs are those that will change if the engines are purchased instead of made. Fixed costs such as supervisor salary, depreciation, and corporate-level costs are irrelevant if they don't change with the decision.

The relevant costs to make 20,000 engines are:

• Materials: $520,000
• Labor: $400,000
• Rental cost of equipment: $23,000

Total relevant costs to make engines = Materials + Labor + Equipment rental = $520,000 + $400,000 + $23,000 = $943,000

So, the maximum price per engine = Total relevant costs / Number of units = $943,000 / 20,000 units = $47.15 per engine.

If production increases to 24,000 units while the other costs remain the same, the maximum price per unit would be:

Maximum price per engine for 24,000 units = Total relevant costs / Number of units = $943,000 / 24,000 units = $39.29 per engine.