Foulds Company makes 10,000 units per year of a part it uses in the products it

Question

Foulds Company makes 10,000 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

$      7.25

Direct labor

11.45

Variable manufacturing overhead

1.65

Fixed manufacturing overhead

        6.00

Unit product cost

$   26. 35

An outside supplier has offered to sell the company all of these parts it needs for $23.25 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 product would be $21,450 per year.

If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, $4.60 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.

Required:

How much of the unit product cost of $26.35 is relevant in the decision of whether to make or buy the part?

What is the total dollar advantage (disadvantage) of purchasing the part rather than making it?

What is the maximum amount the company should be willing to pay an outside supplier per unit if the supplier commits to supplying all 10,000 units required each year?

-- For any calculations, all work must be shown in order to receive full credit.

Direct materials

$      7.25

Direct labor

11.45

Variable manufacturing overhead

1.65

Fixed manufacturing overhead

        6.00

Unit product cost

$   26. 35

Explanation / Answer

The amount of unit product cost that is relevant to the decision of whether to make or buy the part is $ ( 26.35 - 4.60) = $ 21.75

Dollar advantage / disadvantage of purchasing the part:

The dollar advantage of purchasing the product is $ ( 217,500 - 211,050) = $ 6,450

The maximum amount the company should be willing to pay an outside supplier is the total variable cost of $ 20.35 per unit

Make Buy Purchase cost ( $ 23.25 x 10,000) $ 232,500 Contribution margin from use of idle facilities $ ( 21,450) Total variable cost of making ( $ 20.35 x 10,000) $ 203,500 Avoidable fixed cost ( $ 1.4 x 10,000) $ 14,000 Total cost $ 217,500 211,050

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