X Company is considering buying a part next year that they currently make. This

Question

X Company is considering buying a part next year that they currently make. This year's production costs for 3,500 units were: Total Per-Unit Materials $13,895 $3.97 Direct labor [all variable] 15,890 4.54 Variable overhead 10,150 2.90 Fixed overhead 14,350 4.10 A company has offered to supply this part for $13.73 per unit. If X Company buys the part, $8,323 of the fixed overhead can be avoided. Also if X Company buys the part, it can use the freed-up resources to increase production of another product, resulting in additional contribution margin of $2,600. X Company is uncertain what production will be next year. At what production level would it be indifferent between making and buying the part?

Explanation / Answer

Let the units at which X company is indifferent = Units

Cost when Goods are produced in house Next Year

Variable Cost = Direct Material + Direct Labor + Variable over head = 3.97 + 4.54 + 2.90 = $ 11.41

Fixed Overhead = 14,350

Cost A = ( Units X Variable Cost ) + Fixed Over head

= ( Units X 11.41 ) + 14,350

Cost of the goods if purchased from outside

Purchase price = 13.73

Fixed overhead = 14,350 - 8,323 = 6,027

Contribution Margin = 2,600

Cost B = ( Units X Purchase price ) + Fixed overhead - Contribution Margin

= ( Units X 13.73 ) + 6,027 - 2,600

Units at which Cost of X company is indifferent :

Cost A = Cost B

( Units X 11.41 ) + 14,350 = ( Units X 13.73 ) + 6,027 - 2,600

11.41 Units + 14,350 = 13.73 units + 3,427

13.73 units - 11.41 units = 14,350 - 3,427

2.32 units = 10,923

Units = 10,923 / 2.32

Units = 4,708 units

So the answer is at 4,708 units X company will get indifferent

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