Question

1) Baker Corp. manufactures a high-tech recliner for weary professors after accounting classes The motor housing unit costs for 17.500 units direct material 105 direct labor SO variable overhead 60 (10% is avoidable) fixed overhead 40 (95% is a corporate allocation of common costs) A Far East firm has offered to supply the part for $200. a) should the firm accept the outside offer? b) Assume the firm could rent out the manufacturing space used to assemble this part for a yearly rental of $120,000. Does this rental opportunity change the decision? Show all calculations.

Answer 1

a The offer should be accepted if the Company is able to produce the part at less than $200 per unit.

The part can be outsourced for $200.

In-house production cost per unit:

Direct material = $105

Direct labor = $50

Variable overhead (10% of 60) = $6

Fixed overhead (5% of $40) = $2

Total relevant cost = Direct material + Direct labor + Variable overhead + Fixed overhead = $105 + $50 + $6 + $2 = $163 per unit.

As only 10% Variable overhead is avoidable, therefor, only 10% will be considered for the purpose of decision making.

For Fixed Overhead - 95% consists of as common costs which makes it irrelevant and hence, not included above.

Overall, the in-house production of the part is more profitable for the company as it costs only $163 per unit, whereas the same can be outsourced for $200.

b. if the space is rented out which in result generates $120,000 to the company, then the in-house production of the part will be continued only if the savings in cost due to in-house production is more than this amount.

Savings in cost from in-house production = ( Outsource price - In-house production price ) * No. of units manufactured = ( $200 - $163) * 17,500 units = $647,500

Therefore, the above condition due to change our decision as the resulted savings is more than the opportunity cost of renting the space, therefor, the company should continue manufacturing the unit.