Question

Futura Company purchases the 69,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $10.80 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $11.20 as shown below: Per Unit Total Direct materials $ 4.00 Direct labor 3.20 Supervision 1.70 $ 117,300 Depreciation 1.20 $ 82,800 Variable manufacturing overhead 0.60 Rent 0.50 $ 34,500 Total product cost $ 11.20 If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $117,300) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $83,000 per period. Depreciation is due to obsolescence rather than wear and tear. Required: What is the financial advantage (disadvantage) of making the 69,000 starters instead of buying them from an outside supplier?

Answer 1

Financial advantage (disadvantage) of making the 40,000 starters instead of buying them from an outside supplier is: $89,700.

Financial advantage (disadvantage)

First step is to calculate the relevant cost of making starters

Relevant cost= Direct materials+ Direct labor+ Variable manufacturing overhead+ Supervision

Relevant cost=($4×69,000)+ ($3.20×69,000) +($0.60×69,000) + $117,300

Relevant cost=$276,000+$220,800+$41,400+$117,300

Relevant cost=$655,500

Second step is to calculate the relevant cost of buying starters

Relevant cost=$10.80 × 69,000

Relevant cost=$745,200

Third step is to calculate the financial advantage

Financial advantage=$745,200-$655,500

Financial advantage=$89,700

Therefore the financial advantage is $89,700.

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