Barbie Corporation produces an executive jet for which it currently manufactures

Question

Barbie Corporation produces an executive jet for which it currently manufactures a fuel valve; the cost of the valve is indicated below:

Cost per Unit

Variable costs

Direct material

$960

Direct labor

600

Variable overhead

300

Fixed costs

Depreciation of equipment

500

Depreciation of building

250

Supervisory salaries

300

The company has an offer from China Valves to produce the part for $2,000 per unit and supply 1,000 valves (the number needed in the coming year). If the company accepts this offer and shuts down production of valves, production workers and supervisors will be reassigned to other areas. The equipment cannot be used elsewhere in the company, and it has no market value. However, the space occupied by the production of the valve can be used by another production group that is currently leasing space for $55,000 per year.

What is the incremental savings of buying the valves?

Cost per Unit

Variable costs

Direct material

$960

Direct labor

600

Variable overhead

300

Fixed costs

Depreciation of equipment

500

Depreciation of building

250

Supervisory salaries

300

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Avoidable Cost Per Unit = 900 (Direct Material) + 600 (Direct Labor) + 300 (Variable Overhead) + 300 (Fixed Overhead - Supervisor Salaries) = 2100

Total Avoidable Cost = 1000*Avoidable Cost Per Unit = 1000*2100 = 2100000

Total Cost of Purchasing from Outside = 1000*Purchase Price Per Unit = 1000*2000 = 2000000

Total Savings = Total Avoidable Cost - Total Cost of Purchasing from Outside = 2100000 - 2000000 = $100000

Answer is $100000.

Thanks.

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