Howell Corporation produces an executive jet for which it currently manufactures

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

$960

Direct labor

600

Variable overhead

300

Fixed costs

Depreciation of equipment

500

Depreciation of building

200

Supervisory salaries

300

The company has an offer from Duvall 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? (The answer should be stated in a per-unit format and is a positive number)

Your Answer

Explanation / Answer

Incremental Analysis Table:

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The incremental cost of buying the valves per unit is $685,000/1000 = $685 per unit (the company should not buy the valves, but should continue to manufacture).

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Important Information:

a) You will make adjustment for direct labor and supervisory salaries, as they will be assigned to other areas, so the company will continue to incurr these costs, even if the production is shut down, resulting in no savings.

b) Total Cost/(Savings) = Total Variable Cost + Total Fixed Cost + Total Cost Associated with buying Valves

c) Depreciation on equipment and building will also continue to exist as these are fixed costs and are not reduced/eliminated even if the production is shut down, resulting in no savings

d) If the company buys valves, the amount of money directly saved will be towards direct material and variable overhead. Also, the company will save another $55,000 per years towards the lease rent.

Cost of Making 1000 Valves Cost of Buying 1000 Valves Incremental Cost (Savings) Variable costs Direct material (1,000*960) 960,000 0 -960,000 Direct labor (1,000*600) 600,000 600,000 0 Variable OH (1,000*300) 300,000 0 -300,000 Total Variable Costs (a) 1,860,000 600,000 -1,260,000 Fixed costs Depreciation of equipment 500,000 500,000 0 Depreciation of building 200,000 200,000 0 Supervisory salaries 300,000 300,000 0 Total Fixed Costs (b) 1,000,000 1,000,000 0 Other Cost Savings on Leased Space 0 -55,000 -55,000 Cost of Buying Valves (1,000*2,000) 0 2,000,000 2,000,000 Total Cost Associated with buying (c) 0 1,945,000 1,945,000 Total (a + b + c) $2,860,000 $3,545,000 $685,000

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