Question

A company manufactures one of its crucial parts at a cost of $150 per unit. This cost is based on normal production of 10,000 units per year. Variable costs are $109 per unit, fixed costs related to making this part are $10,000 per year ($1 per unit), and allocated fixed cost are $400,000 per year ($40 per unit). Allocated fixed costs are unavoidable whether the company makes or buys this component. The company is considering buying the part from a supplier for a quoted price of $100 per unit guaranteed for a three-year period. What is the company's cost savings?

Answer 1

The company's cost savings is $10 per unit.

Step-by-step explanation:

Since the allocated fixed cost of $400,000 per year ($40 per unit) are unavoidable whether the company makes or buys this component, this will not be in the company's cost to determine the cost saving as follows:

Company's avoidable cost per unit = Variable costs per unit + Related fixed cost per unit = $109 + $1 = $110

Company's cost savings per unit = Company's avoidable cost per unit - Supplier's quotation per unit = $110 - $100 = $10 per unit

Total cost saving from normal production per year = 10,000 × $10 = $100,000

Total cost saving from normal production for the next 3 years = $100,000 × 3 = $300,000