Make or Buy Decision Question Managerial Accounting

Question

Ahron Company makes 8,000 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows :

 

Direct Materials : $14.90

Direct Labor : $17.50

Variable Manufacturing Overhead : $1.90

Fixed Manufacturing Overhead : $21.10

Unit Product Cost : $55.40

 

An outside supplier has offered to sell the company all of the units it needs. If the company accepts this offer, the facilities now being used to make this part would be used to make more units of a product in high demand. The additional contribution margin on the other product would be $161,600 per year. If the part were purchased from the outside supplier, $7.50 of the fixed manufacturing overhead cost being applied to the part would be eliminated. What is the maximum amount the company should be willing to pay an outside supplier for part if supplier commits to supplying all 8,000 units required for the year?

 

A) 49.50 B) 62.00 C) 48.80 D) 55.40 E) None of above

 

Answer was C) but I need help with steps as to how and why.

 

Thanks.

Answer 1

I ask myself which cost element among the MFG costs that will be impacted the most in any "Make or Buy" decisions and in this case it is the Fixed MFG overhead $21.10/unit. So, if the company decide to outsource the Mfg of this part to a third party, it will save $7.5 in Fixed MFG Overhead or 21.10-7.5= $13.6/unit will be used to produce another product in high demand. So, to come up with the pricing calculation we need to compare outcomes:

                                      Old Make   Replace    Savings

           Production units     8000         8000             

           Unit Profit margin                 $20.20  

           Unit Cost                $55.40   

           Fixed MFG OH        ($21.10) ($13.60)    $7.50                 

           Net OUTCOME         $34.30 + $6.60  +  $7.50   = $48.40

The $48.40 represents the maximum price for outsourcing the part to third party.