Howell Corporation produces an executive jet for which it currently manufactures
ID: 2628415 • Letter: H
Question
Howell Corporation produces an executive jet for which it currently manufactures a fuel valve; the cost of the valve is indicated below:
Cost per Unit
Variable costs
Direct material $940
Direct labor 600
Variable overhead 300
Fixed costs
Depreciation of equipment 500
Depreciation of building 225
Supervisory salaries 300
The company has an offer from China Valves to produce the part for $2,000 per unit and supply 1,000 valves (the number needed in the coming year). 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 elsewhere in the company, and it has no market value. However, the space occupied by the production of the valve can be used by another production group that is currently leasing space for $55,000 per year.
What is the incremental savings of buying the valves?
Explanation / Answer
Particulars
Produce the Product
Purchase the product
Direct Material
940
0
Direct Labour
600
0
Direct Overhead
300
0
Total Variable Cost (A)
1,840
0
Depreciation of Equipment
500
500
Depreciation of Building
225
0
Supervisory Salaries
300
0
Total Fixed Cost (B)
1,025
500
Total Cost (A+B)
2,865
500
If the company produces the product then the total cost of $2,865 will have to be incurred but if the company buys the product then its cost comes out to be $2000+$500 because the equipment cannot be used elsewhere and it has to borne by the company as fixed cost .Therefore if the company buys the valve then it has to incur $2,500 but if it produce the product it has to incur $2,865. Therefore it is beneficial for the company to buy the product rather than to produce the product.
Particulars
Produce the Product
Purchase the product
Direct Material
940
0
Direct Labour
600
0
Direct Overhead
300
0
Total Variable Cost (A)
1,840
0
Depreciation of Equipment
500
500
Depreciation of Building
225
0
Supervisory Salaries
300
0
Total Fixed Cost (B)
1,025
500
Total Cost (A+B)
2,865
500
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