Ahrensfeld Company makes 40,000 units per year of a part it uses in the products

Question

Ahrensfeld Company makes 40,000 units per year of a part it uses in the products it manufactures.

The unit product cost of this part is computed as follows:

* Direct materials = $10.90

* Direct labor = $15.10

* Variable manufacturing overhead 1.90

* Fixed manufacturing overhead 18.00

* The total unit product cost = $45.90

An outside supplier has offered to sell the company all of these parts it needs for $31.80 a unit.

If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be $80,000 per year.

If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, $13.80 of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the company's remaining products.

What is the net total dollar advantage (disadvantage) of purchasing the part rather than making it?
1) $80,000
2) $92,000
3) $12,000
4) $564,000

Explanation / Answer

2) $92,000 remember to rate

"If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, $13.80 of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier."

This is telling us to take that $13.80 and slap it onto the purchasing cost of $31.80

31.8 + 13.8 = $45.60

Currently, the total unit product cost is $45.90 so it looks like we should buy, right? Wrong.

If we buy we will make an additional $80,000 on other products so lets allocate this 80,000 to our units. 80000/40000 = $2 per unit extra if we buy. So subtract this from our cost of buying the unit. 45.6 - 2 = $43.60. Now multiply each of these by the total units to find the total costs of each:

Buy: 43.6 x 40,000 = $1,744,000
Make: 45.9 x 40,000 = $1,836,000

$1,836,000 - $1,744,000 = $92,000 net advantage of buying (buying is less).

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