1. Zorro Manufacturing had always made its components in house. However, Simpson

Question

1.       Zorro Manufacturing had always made its components in house. However, Simpson Components Works had recently offered to supply one component, P7-43, at a price of $5 each. Zorro uses 3,850 units of component P7-43 each year. The absorption cost per unit of this component is as follows:

        Direct Materials            $1.30

        Direct Labor                       .65

         Variable Overhead         2.50

          Fixed Overhead              3.00

          Total                               $7.45

The fixed overhead is an allocated expense; none of it would be eliminated if production of component P7-43 stopped.

Required:

a.       What are the alternatives facing Zorro Manufacturing with respect to production component P7-43?

b.      List the relevant cost for each alternative. Which alternative is better?

Explanation / Answer

Hi,

Please find the answers as follows:

Part A:

Zorro manufacturing can either purchase the component from outside supplier or continue to produce the item in-house. If the component is purchased from outside supplier, the cost would be as follows:

Alternative 1:

If it is manufactured in-house

Total Cost = 7.45

Alternative 2:

Purchase Price = 5

Fixed Cost = 3 (since it will not be eliminated)

Total = 8 per component

Part B:

Alternative 1:

Relevant Cost would be: 1.30 +.65 + 2.5 = 4.45

Alternative 2:

Relevant Cost would be: 5

Alternative 1 should be chosen as it results in lower cost for the firm.

Thanks.

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