Case 1

Hairdo Products manufactures 30,000 units of part K-7 each year for use on its production line. At this

level of activity, the cost per unit for part K-7 is:

Direct materials . . . . . . . . . . . . . . . . . . . . . $ 4

Direct labor . . . . . . . . . . . . . . . . . . . . . . . . $12

Variable manufacturing overhead . . . . . . . $5

Fixed manufacturing overhead . . . . . . . . . $12

Total cost per part . . . . . . . . . . . . . . . . . . . $25

An outside supplier has offered to sell 20,000 units of part K-7 each year to Hairdo Products for $21

per part. If Hairdo Products accepts this offer, the facilities now being used to manufacture part K-7

could be rented to another company at an annual rental of $100,000. However, Hairdo Products has

determined that two-thirds of the fixed manufacturing overhead being applied to part K-7 would

continue even if part K-7 were purchased from the outside supplier.

Required:

Prepare computations showing how much profits will increase or decrease if the outside suppliers

offer is accepted.