Question

Han Products manufactures 20,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is: Direct materials $ 3.40 Direct labor 8.00 Variable manufacturing overhead 2.60 Fixed manufacturing overhead 9.00 Total cost per part $ 23.00 An outside supplier has offered to sell 20,000 units of part S-6 each year to Han Products for $19 per part. If Han Products accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental of $70,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier. Required: What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?

Answer 1

Financial advantage of accepting the outside supplier’s offer = $30,000

Step-by-step explanation:

The relevant cash flow from the accepting the offer of the outside suppliers include :

1. Extra variable cost of buying
2. Savings in direct fixed manufacturing overhead
3. Gains from annual rental income from facility

Unit variable cost of making: 3.40 + 8+ 2.60 = 14

Direct fixed manufacturing overhead (1/3× 19× 20,000)= 60,000

$

Variable cost of external purchase ( 19× 20,000) 380,000

Variable cost of making (14 × 20,000) (280,000)

Extra variable cost of buying (100,000)

add savings in manufacturing overhead 60,000

add revenue from rental charge 70,000

Net financial advantage from buying 30,000

Financial advantage of accepting the outside supplier’s offer = $30,000