Question

Fothergill Company makes 40,000 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows:

Direct materials $23.40
Direct labor 22.30
Variable manufacturing overhead 1.40
Fixed manufacturing overhead 24.60
Unit product cost $71.70
An outside supplier has offered to sell the company all of these parts it needs for $59.10 a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be $390,000 per year. If the part were purchased from the outside supplier, all of the direct labor, direct materials and variable manufacturing overhead costs of the part would be avoided. However, $21.90 of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the company's remaining products.
Required:
a. How much of the unit product cost of $71.70 is relevant in the decision of whether to make or buy the part?
b. What is the net total dollar advantage or (disadvantage) of purchasing the part rather than making it? (remember that the facility could be used to produce a different product if we purchased the parts from the outside).
c. What is the maximum amount the company should be willing to pay an outside supplier per unit for the part if the supplier commits to supplying all 40,000 units required each year?

Answer 1

Answer and Explanation:

The computation is shown below:

a)

cost per unit

= direct materials + direct labor + variable manufacturing overheard + fixed manufacturing over eard

= $23.40 + $22.30 + $1.40 + ($24.60 - $21.90)

= $49.80

b)

The net advantage is

= manufacturing cost savings + addition contribution margin - cost of purchase of part

= $1,992,000 (40,000 ×$49.80) + $390,000 - $2,364,000 (40,000 × $59.10)

= $18,000

c)

total benefit is

= $1,992,000 + $390,000

= $2,382,000

Now

maximum amount per unit is

= $2,382,000 ÷ 40000

= $59.55