Question 1 Sherman Machine Corporation incurs the following estimated annual cos

Question

Question 1

Sherman Machine Corporation incurs the following estimated annual costs in making a

       subassembly for one of its products:

                                                                        Total Cost for

                                                                        20,000 units       Unit Cost

            Factory Overhead:

            Variable                                               $ 300,000              $15

            Fixed                                                  $ 960,000              $48

            Direct Labor                                        $ 900,000              $45

            Direct Materials                                  $ 600,000              $30

Another manufacturer offers to sell Sherman Machine the same subassembly for $91 per

unit for 20,000 units per year. Determine whether Sherman Machine should make or buy the subassembly, assuming that the plant capacity now used to make the subassembly would

become idle if they were purchased and that $230,000 of the fixed factory overhead could be avoided by not making the subassembly.

Explanation / Answer

Analysis of make or Buy decision 1) Particulars Workings Amount($) Cost of Buying 20000 Units =20000*91 1820000 Add: Unavoidable fixed cost =960000-230000 730000 Cost of Buying 2550000 2) Cost Of Making Direct Material =30*20000 600000 Direct Labour =45*20000 900000 Variable OH =15*20000 300000 Fixed Over Head 960000 960000 Cost Of Making 2760000 Since Option 1 is more favourable as it is less costly Hence it is prefered to buy rather than making

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