VARIABLE COSTS DIRECT MATERIAL 960 DIRECT LABOR 600 VARIABLE OVERHEAD 300 TOTAL
ID: 2622291 • Letter: V
Question
VARIABLE COSTS
DIRECT MATERIAL 960
DIRECT LABOR 600
VARIABLE OVERHEAD 300
TOTAL VARIABLE COSTS 1800
FIXED COSTS
DEPRECIATION OF BUILDING 200
DEPRECIATION OF EQUIPMENT 500
SUPERVISORY SALARIES 300
TOTAL FIXED COSTS 1000
TOTAL COST 2800
OFFER FROM COMPANY TO PRODUCE THE PART FOR $2000 PER UNIT AND SUPPLY 1000 VALVES. 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 ELSWHERE IN THE COMPANY AND HAS NO MARKET VALUE. HOWEVER THE SPACE OCCUPIED BY PRODUCTION OF THE VALVE CAN BE USED BY ANOTHER PRODUCTION GROUP THAT IS CURRENTLY LEASING SPACE FOR $55000 PER YEAR. WHAT IS THE INCREMENTAL SAVINGS OF BUYING THE VALVES?
Explanation / Answer
Costs that can be avoided as a result of purchasing from the outside are played important role in make-or-buy decision.
Per unit costs
1000 units
Make
Buy
Make
Buy
Cost of purchasing
$2,000
$2,000,000
Cost of making:
DIRECT MATERIAL
$900
$900,000
DIRECT LABOR
600
600,000
VARIABLE OVERHEAD
300
300,000
SUPERVISORY SALARIES
300
300,000
TOTAL COST
$2,100
$2,100,000
$2,000,000
The $55,000 per year rental value represents an opportunity cost of continuing to produce the part internally. Thus, the analysis would be:
Make
Buy
TOTAL COST
$2,100,000
$2,000,000
Rental value of the space (opportunity cost)
$55,000
TOTAL COST including opportunity cost
$2,155,000
$2,000,000
Conclusion:
From the above calculation, we can see that the incremental savings of buying the valves is $155,000.
Per unit costs
1000 units
Make
Buy
Make
Buy
Cost of purchasing
$2,000
$2,000,000
Cost of making:
DIRECT MATERIAL
$900
$900,000
DIRECT LABOR
600
600,000
VARIABLE OVERHEAD
300
300,000
SUPERVISORY SALARIES
300
300,000
TOTAL COST
$2,100
$2,100,000
$2,000,000
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