Gerenuk Company currently produces a key part at a total cost of $120,000. Annua

Question

Gerenuk Company currently produces a key part at a total cost of $120,000. Annual variable costs are $35,000. Of the annual fixed costs, $12,000 relate specifically to this part. The remaining fixed costs are unavoidable.

Another manufacturer has offered to supply the part annually for $110,000. The facilities currently used to manufacture the part could be used to manufacture a new product with an expected contribution margin of $65,000 per year. Alternatively, the facilities could be rented out at $25,000 per year. Given all of these alternatives, what is Gerenuk Company's lowest net relevant cost for the parts?

You must show your calculations.

Hint: Your three alternatives are (1) make the part, (2) buy the part and manufacture a new product, (3) buy the part and rent out the facilities.

Explanation / Answer

a) Make the part: Cost would be 120,000

contribution margin= Cost- variable cost= 120,000-35000= 85000

b) Buy part and manufacture: Cost of part= 110,000

Fixed cost= 12000

total cost= 122,000

Contribution Margin= 65000

c) Buy the part and rent facilities:

Cost of part:110,000

Rent expected: 25000

Total cost= 110,000

Contribution Margin per year= 65000 + Rent per year= 90000

Option c is the most cost effective and with highest contribution margin option.

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