Question
Please explain if i need to multiply the make and buy amounts by sold 20,000 units or manufactured 20,000 units. And why? That's it. Thank
Please explain if i need to multiply the make and buy amounts by sold 20,000 units or manufactured 20,000 units. And why? That's it. Thank you.
Exercise 10-12 Make or Buy a Component [LO3]
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: |
Direct materials | $ | 4.80 |
Direct labor | 7.00 | |
Variable manufacturing overhead | 3.20 | |
Fixed manufacturing overhead | 10.00 | |
Total cost per part | $ | 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: |
a. | What is the total relevant cost of making the product? |
Total relevant cost of making the product (20,000 units) | $ |
b. | What is the total relevant cost of buying the product? |
Total relevant cost of buying the product (20,000 units) | $ |
c. | What is the opportunity cost of making instead of buying? |
Total opportunity cost | $ |
d. | How much profits will increase or decrease if the outside suppliers offer is accepted? (Input the amount as a positive value.) |
Profits would increase by | $ |
Explanation:
The costs that can be avoided as a result of purchasing from the outside are relevant in a make-or-buy decision. The analysis is: |
Per Unit Differential Costs | 20,000 Units | ||||||||
Make | Buy | Make | Buy | ||||||
Cost of purchasing | $ | 23.50 | $ | 470,000 | |||||
Cost of making: | |||||||||
Direct materials | $ | 4.80 | $ | 96,000 | |||||
Direct labor | 7.00 | 140,000 | |||||||
Variable manufacturing overhead | 3.20 | 64,000 | |||||||
Fixed manufacturing overhead | 4.00 | * | 80,000 | ||||||
Total cost | $ | 19.00 | $ | 23.50 | $ | 380,000 | $ | 470,000 | |
*The remaining $6 of fixed manufacturing overhead cost would not be relevant because it will continue regardless of whether the company makes or buys the parts. |
The $150,000 rental value of the space being used to produce part R-3 is an opportunity cost of continuing to produce the part internally. Thus, the complete analysis is: |
Make | Buy | |||
Total cost, as above | $ | 380,000 | $ | 470,000 |
Rental value of the space (opportunity cost) | 150,000 | |||
Total cost, including opportunity cost | $ | 530,000 | $ | 470,000 |
Net advantage in favor of buying | $60,000 | |||
Profits would increase by $60,000 if the outside suppliers offer is accepted. |
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