The Novelty Company, a manufacturer of farm equipment, currently produces 20,000 units of gas filters per year for use in its lawn-mower production. The costs, based on the previous year's production, are reported in Table P6.29.
It is anticipated that gas-filter production will last five years. If the company continues to produce the product in-house, annual direct material costs will increase at the rate of 5%. (For example, annual material costs during the first production year will be $63,000.) Direct labor will increase at the rate of 6% per year, and variable overhead costs will increase at the rate of 3%. However, the fixed overhead will remain at its current level over the next five years. The John Holland Company has offered to sell Novelty 20,000 units of gas filters for $25 per unit. If Novelty accepts the offer, some of the manufacturing facilities currently used to manufacture the filter could be rented to a third party for $35,000 per year. In addition, $3.5 per unit of the fixed overheard applied to the production of gas filters would be eliminated. The firm's interest rate is known to be 15%. What is the unit cost of buying the gas filter from the outside source? Should Novelty accept John Holland's offer, and why?

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Expense ($) S 60,000 180,000 135,000 70,000 $445,000 Item Direct materials Direct labor Variable overhead (power and water) Fixed overhead (light and heat) Total cost