If Han Products accepts the offer from the outside supplier, the profits will increase by $90,000. This is calculated as follows:
Current cost of producing 30,000 units of part S-6:
Direct materials: $108,000
Direct labor: $300,000
Variable manufacturing overhead: $72,000
Fixed manufacturing overhead: $270,000
Total cost: $750,000
Cost of purchasing 30,000 units of part S-6 from outside supplier:
Cost of purchasing: $630,000
Savings from purchasing from outside supplier:
Savings: $120,000
Fixed manufacturing overhead that will continue even if part S-6 is purchased from outside supplier:
Fixed manufacturing overhead: $180,000
Net savings from purchasing from outside supplier:
Net savings: $90,000
Increase in profits from purchasing from outside supplier:
Increase in profits: $90,000
Han Products manufactures 30,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is as follows:
Direct materials
$ 3.60
Direct labor
10.00
Variable manufacturing overhead
2.40
Fixed manufacturing overhead
9.00
Total cost per part
$25.00
An outside supplier has offered to sell 30,000 units of part S-6 each year to Han Products for $21 per part. If Han Products accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental of $80,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier. Prepare computations showing how much profits will increase or decrease if the outside supplier’s offer is accepted.
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