EXERCISE 1212 Make or Buy a Component

Royal Company manufactures 20,000 units of part R-3 each year for use on its production line. At this level of activity, the cost per unit for part R-3 is: Discontinuing the overnight cases would not affect the companys sales of its other product lines, its total general factory overhead, or its total purchasing department expenses. Required: Would you recommend that the company discontinue the manufacture and sale of overnight cases? Support your answer with appropriate computations

Direct materials . . . . . . . . . . . . . . . . . . . . $ 4.80

Direct labor. . . . . . . . . . . . . . . . . . . . . . . . 7.00

Variable manufacturing overhead . . . . . . . 3.20

Fixed manufacturing overhead. . . . . . . . . 10.00

Total cost per part. . . . . . . . . . . . . . . . . . . $25.00

$25.00 An outside supplier has offered to sell 20,000 units of part R-3 each year to Royal Company for $23.50 per part. If Royal Company accepts this offer, the facilities now being used to manufacture part R-3 could be rented to another company at an annual rental of $150,000. However, Royal Company has determined that $6 of the fixed manufacturing overhead being applied to part R-3 would continue even if part R-3 were purchased from the outside supplier. Required: Prepare computations showing how much profits will increase or decrease if the outside suppliers offer is accepted.