Royal Company manufactures 20,000 units of part R-3 each year for use on its pro
ID: 2670043 • Letter: R
Question
Royal Company manufactures 20,000 units of part R-3 each year for use on its production line. At this level of activity, the cost per unit for part R-3 is:Direct Material $ 4.80
Direct Labor 7.00
Variable Manufacturing Overhead 3.20
Fixed Manufacturing Overhead 10.00
Total Cost Per Part $ 25.00
An outside supplier has offered to sell 20,000 units of part R-3 each year to Royal Company for $23.50 per part. If Royal Company accepts this offer, the facilities now being used to manufacture part R-3 could be rented to another company at an annual rental of $150,000. However, Royal Company has determined that $6 of the fixed manufacturing overhead being applied to part R-3 would continue even if part R-3 were purchased from the outside supplier.
Required:
Prepare computations showing how much profits will increase or decrease if the outside supplier's offer is accepted.
Explanation / Answer
Fixed costs are sunk costs ($6*20000 = $120,000) & will continue to be incurred or wil be allocated to other products if R-2 is discontd. So it is not relevant in decision making here. Oher Var costs pu = Dir Mat + DIr Lab + Var Mfg cost = 4.80+7+3.20 = 15 SO current Make cost pu is $15 while buy cost pu is $23.50 ie more by $8.50 pu. So loss due to Buy decision will be $8.50*20000 = $170,000 So Total Loss = Fixed cost + Loss due to buy = 120,000+170,000 = 290,000 Less Rental income = $150000 ------------------------------------------ So Net Income will reduce by 290,000-150,000 = 140,000 due to Buy decision. So Outside supplier offer shouldnot be accepted.
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