Question

Stephans Corporation currently manufactures a subassembly for its main product. The costs per unit are as follows: Direct materials $ 1.00 Direct labor 10.00 Variable overhead 5.00 Fixed overhead 8.00 Total $24.00 Bill Company has contacted Stephans with an offer to sell them 5,000 of the subassemblies for $22.00 each. Stephans will eliminate $25,000 of fixed overhead if it accepts the proposal. Should Stephans make or buy the subassemblies? What is the difference between the two alternatives?

Answer 1

Answer:

Stephans shall make the product.

The difference is of $5,000 to be saved in case of making the product.

Explanation:

Provided details,

Cost per unit

Variable = Direct material $1 + Direct Labor $10 + Variable Overhead $5.00

= $16

Fixed overhead = $8

Including fixed cost the cost per unit of manufacturing = $16 + $8 = $24

In case of buying cost = $22 per unit.

Cost for 5,000 units in case of buying = $22 $\times$ 5,000 = $110,000

Cost of making 5,000 units = $24 $\times$ 5,000 = $120,000

Fixed cost for 5,000 units = $8 $\times$ 5,000 = $40,000

$25,000 cost is avoidable.

Therefore non avoidable cost = $40,000 - $25,000 = $15,000

Therefore total cost of purchasing = $110,000 + $15,000 = $125,000

Since total cost of purchasing is more than cost of making, goods shall be manufactured and not produced.

Difference = $125,000 - $120,000 = $5,000 additional in case of purchasing.