Howell Corporation produces an executive jet for which it currently manufactures
ID: 2758447 • Letter: H
Question
Howell 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 $900
Direct labor 600
Variable overhead 300
Fixed costs
Depreciation of equipment 500
Depreciation of building 200
Supervisory salaries 300
The company has an offer from Duvall 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? (The answer should be stated in a per-unit format and is a positive number)
Explanation / Answer
Cost per Unit Variable costs: Direct material $ 900.00 Direct labor $ 600.00 Variable overhead $ 300.00 $ 1,800.00 Fixed costs : Depreciation of equipment $ 500.00 Depreciation of building $ 200.00 Supervisory salaries $ 300.00 $ 1,000.00 Total cost $ 2,800.00 Company gets an offer from Duvall Values for 1000 Valves @ $ 2,000 per year Per Unit Total Manufacturing Cost (*Variable) $ 1,800.00 $ 1,800,000.00 Purchase Cost $ 2,000.00 $ 2,000,000.00 Saving in labour cost $ (600.00) $ (600,000.00) Leasing income by free space $ (55,000.00) Incremental Saving due to purchase option $ 455,000.00 *Note : Fixed cost are sunk cost , These cost are not relevant for decision making purpose
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