Santos co. currently manufactures on of its crucial parts at a cost of $3.40 PU.

Question

Santos co. currently manufactures on of its crucial parts at a cost of $3.40 PU. This cost is based on a normal production rate of 50,000 units per year. Variable costs are $1.50 per unit, fixed costs related to making this part are $50,000 per year and allocated fixed costs are $45,000 per year. Allocated fixed costs are unaboidable whether the company makes or buys the part. Santos is considering buying the part from a supplier for a quoted price of $2.70 per unit guaranteed for a three-year period. Should the company continue to manufacture the part, or should it buy the part from the outside supplier?

Explanation / Answer

Out sourcing contribution = ($2.70 - $1.50) = $1.2 Own production contribution = ( $3.40- $1.50) = $1.90 Change in fixed / change in variable = (50000 - 0 ) / (1.9 - 1.2) = 71,428.57 units It is better to out source till the units are 71,428.57 units and then he should manufacture the part

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