Problem 3

The Little Red Wagon Company makes 2,000 axels per year for use in production of their eponymous product. Data concerning the unit production costs of the axels follow:

Direct Materials	$ 5
Direct Labour	$ 3
Variable Manufacturing Overhead	$ 4
Fixed Manufacturing Overhead	$10
Total Manufacturing Cost per Unit	$22

An outside supplier has offered to sell the company all of the axels it requires. If the company decided to discontinue making the axels, 40% of the above fixed manufacturing overhead costs could be avoided. Assume that direct labour is a variable cost.

Required:

1. Assume the company has no alternative use for the facilities presently devoted to production of the axels. If the outside supplier offers to sell the axels for $18 each, should the company accept the offer? Fully support your answer with appropriate calculations.

2. Assume that the company could use the facilities presently devoted to production of the axels to expand production of another product that would yield an additional contribution margin of $10,000 annually. What is the maximum price the company should be willing to pay the outside supplier for axels?