6. (6 pts) A Texas company manufactures all the parts for their primary product,

ID: 2511301 • Letter: 6

Question

6. (6 pts) A Texas company manufactures all the parts for their primary product, then assembles and sell the product. It recently received an offer from a company in California to make one of their parts for their product. The CA company is willing to sell the part fer $30/pard To continue making the part, the Texas company will need to purchase and replace a production (the old one is no longer economically viable and has zero salvage value) at a cost of $300K) They estimate it will last for another 5 years. The straight line depreciation of the new machine(is S60 Kr. They estimate the need for 2 0K parts over the next five years (4K/yr). The Texas company has the following cost data on the part: Cost/part S12 $8 Direct Material Direct Labor Variable Overhead Depreciation Supervision Rent $3 $1.50 totel cat)?32 If they buy the part, a supervisor would no longer be required. The rent charge is based on the allocated space in their manufacturing facility for the manufacture of the part, but there is already excess plant space. The rent for it is $25Kyr and will have to be paid regardless. Should the part be made internally or purchased from the CA company?

Explanation / Answer

As per information of the question, it is given that CA company is willing to sell that part at $30 per part. Hence if per part cost of making is low than $30 then it should be made internally or vice versa.

Thus let’s calculate cost of per part required to make it internally;

Direct material

$12

Direct labor

Variable overhead

$4.50

Depreciation ($300000 / 20000)

$15

Supervision (It is required if made internally)

$1.50

Total cost of a part if made internally

$41

Note:

1. Rent will not be included in the cost of making part because rent expense is fixed and will not be affected with manufacturing of this specific part.

2. Supervision expesnses will be included because it is given that if we purchase that part from CA company then supervision will not be required hence it will be required in case of manufacturing internally.

And we know that cost of buying from CA company is $30 per part which is far below than cost of making internally that is $41 per part. Hence this part should be purchased from CA company because it will result into low cost and ultimately it will result into higher net income.