Make or Buy a Component [LO3] Royal Company manufactures 20,000 units of part R-

Question

Make or Buy a Component [LO3] 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 materials $ 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's Prepare computations showing how much profits will increase or decrease if the outside supplier's offer's accepted

Explanation / Answer

Totalrelevant costof making the product:

$4.80 + $7.00 + $3.20 + ($10.00 - $6.00) = $19.00 * 20,000 = $380,000 + $150,000 = $530,000

Total relevant cost of buying this product:

$23.50 * 20,000 = $470,000

Totalopportunity cost:

$150,000

How much profits will increase or decrease if the outside supplier's offer is accepted:

$530,000 - $470,000 = $60,000 (increase)

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