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Make-or-Buy Analysis for Part S-6

Han Products currently manufactures 30,000 units of part S-6 per year at a total cost of $25 per unit. An outside supplier has offered to provide the same number of units for $21 each. While some fixed costs would still be incurred if Han bought the parts, purchasing them would free up space that could be rented for $80,000 annually. An analysis shows that accepting the supplier's offer would save Han $20,000 per year after accounting for this opportunity cost.

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Eevan Salazar
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595 views1 page

Make-or-Buy Analysis for Part S-6

Han Products currently manufactures 30,000 units of part S-6 per year at a total cost of $25 per unit. An outside supplier has offered to provide the same number of units for $21 each. While some fixed costs would still be incurred if Han bought the parts, purchasing them would free up space that could be rented for $80,000 annually. An analysis shows that accepting the supplier's offer would save Han $20,000 per year after accounting for this opportunity cost.

Uploaded by

Eevan Salazar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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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 accept 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.

Required: Prepare computation showing how much profit will increase or decrease if
the outside supplier’s offer is accepted.

Solution:
The costs that are relevant in a make-or-buy decision are those costs that can be avoided
as a result of purchasing from the outside. The analysis for this exercise is:

Per unit differential


cost 30,000 Units
Make Buy Make Buy
Cost of purchasing ……. $ 21.00 $ 630,000
Cost of making:
Direct materials $ 3.60 $ 108,000
Direct labor 10.00 300,000
Variable overhead 2.40 72,000
Fixed overhead 3.00 90,0000 00
Total cost $19.00 $ 21.00 $ 570,000 $ 630,000

The $80,000 rental value of the space being used to produce part S-6 represents an
opportunity cost of continuing to produce the part internally. Thus, the completed
analysis would be:
Make Buy
Total cost, as above......................................... $570,000 $630,000
Rental value of the space (opportunity cost) ....... 80,000 ………...
Total cost, including opportunity cost ................. $650,000 $630,000
Net advantage in favor of buying .......................... $20,000

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