Hardware Company manufactures a part for its production cycle. The annual costs

Question

Hardware Company manufactures a part for its production cycle. The annual costs per unit for 20,000 units of this part are as follows:
Direct Materials $15
Direct Labor $12
Indirect Production Costs-Variable $19
Indirect Production costs-fixed $16
Total Cost $62

Hardware Company has been approached by a supplier who will sell 20,000 units of the same part for $940,000. All the fixed indirect production costs are unavoidable if Hardware Company ceases production of the part.

Required:
A) Assuming there is no alternative use for the facilities, should Hardware Company buy or make the part?
B) Assume the facilities can be rented out for $100,000 per year. Should Hardware Company buy the part? If so, how much money will be saved?

Explanation / Answer

Dir Mat $15 Dir Lab $12 Var Prod cost $19 ------------------------------- Total Var cost pu $46 Supplier Offer is $940,000/20000 = $47 pu A> If there is no alternative for faclities, it is better to make the part as it is cheaper by $1 pu. SO Total saving v/s Buy decision is $20000 for 20000 units B. If caility can be rented out for $100,000 then we should buy teh part. Incremental extra cost of buying is $1*20000 = $20000. So Nte addl Income by renting out is $100000-$20000 = $80000. SO an amount of $80000 will be saved by buying the part.

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