X Company currently makes a part and is considering buying it from a company has

Question

X Company currently makes a part and is considering buying it from a company has offered to supply it for $16.24 per unit. This year, per-unit production costs to produce 54,000 units were:

$151,200 of the total overhead costs were variable; $27,216 of the fixed overhead costs can be avoided if X Company buys the part. In addition, the resources that were used for production can be rented to another company for $70,000. Production next year is expected to increase to 58,300 units.

1. If X Company buys the part instead of making it, it will save____?

2. X Company is uncertain about next year's production level. At what production level will the company be indifferent between making and buying the part?

Explanation / Answer

1. cost of making part = (direct material + labour + variable oh) * total units + fixed OH

=(5.9 + 5.9 + 2.8) *58300 + 97200

= $ 948380

WN : variable OH rate = 151200 / 54000 = 2.8

fixed OH = total - variable = 4.6 * 54000 - 151200 = 97200

cost of buying part = purchase cost + unavoidable fixed cost - rent income from resources

= 16.24 * 58300 + (97200 - 27216) - 70000

= $ 946776

saving in cost = cost of making - cost of buying

= 948380 - 946776

=$ 1604

2. for indifferent , let production level = x

cost of making = cost of buying

(5.9 + 5.9 +2.8)* x + 97200 = 16.24 * x +69984 - 70000

14.6 x + 97200 = 16.24 x -16

1.64 x = 97216

x= 59278 units

at 59278 units, company will be indifferent between making and buying the part.

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