Monash Company is currently manufacturing part Z911, producing 40,000 units annually. The part is used in the production of several products made by Monash. The cost per unit for Z911 is as follows:

Question

Direct Materials $9.00
Direct Labour 3.00
Variable Overhead 2.50
Fixed Overhead 4.00
Total $18.50

Of the total fixed overhead assigned to Z911, $88,000 is direct fixed overhead (the lease of production machinery and salary of a production line supervisor – neither of which will be needed if the line is dropped). The remaining fixed overhead is common fixed overhead. An outside supplier has offered to sell the part to Monash for $16. There is no alternative use for the facilities currently used to produce the part.

Required
1. Should Monash make or buy part Z911? Justify
2. What is the most Monash would be willing to pay an outside supplier?
3. If Monash bought the part, by how much would income increase or decrease?

Now suppose that all of the fixed overhead is common fixed overhead.

Required
1. Should Monash make or buy part Z911? Justify
2. What is the most Monash would be willing to pay an outside supplier?
3. If Monash bought the part, by how much would income increase or decrease?

Answer 1

1. Monash should buy part Z911. The cost of producing the part is $18.50 per unit, while the outside supplier is offering to sell the part for $16. This means that Monash would save $2.50 per unit by buying the part from the outside supplier. This would result in a total savings of $100,000 per year.

2. The most Monash would be willing to pay an outside supplier is $16 per unit. This is the price the supplier is offering to sell the part for.

3. If Monash bought the part, income would increase by $100,000 per year. This is the amount of money Monash would save by buying the part from the outside supplier instead of producing it themselves.