Answer:
12,000 units
outside supplier offers at $27.40 each = $328,800
current relevant costs:
- direct materials $7.20 x 12,000 = $86,400
- direct labor $7.10 x 12,000 = $85,200
- variable overhead $3.50 x 12,000 = $42,000
- supervisor's salary $4.70 x 12,000 = $56,400
- total = $270,000
only $6,000 of allocated fixed costs can be avoided
additional revenue from using the freed space $29,000
A. Prepare a report that shows the effect on the company's total net operating income of buying part B76 from the supplier rather than continuing to make it inside the company.
Keep Buy Differential
producing from vendor amount
production cost $270,000 $0 $270,000
purchase cost $0 $328,800 ($328,800)
avoidable costs $0 ($6,000) $6,000
<u>additional revenue $0 ($29,000) $29,000</u>
total $270,000 $293,800 ($23,800)
B. Identify which alternative the company should choose and explain why.
The company should keep producing the part because production costs are lower than buying it from an outside vendor.
C. Determine what errors managers may make when considering make or buy decisions and basing the decision solely on the data?
If we had made this decision based on total production costs, then management would have erroneously chosen to purchase the part from an outside vendor. Total production costs are $28.30 per unit, but almost $5.80 per unit are not avoidable (mostly fixed and general overhead), so the company will incur them no matter what. You have to compare only relevant costs or revenues.
