Han Products manufactures 60,000 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 $ 6.50
Direct labour 12.50
Variable overhead 5.50
Fixed overhead 10.80
Total cost per part $ 35.30
An outside supplier has offered to sell 53,000 units of part S-6 each year to Han Products for $31.00 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 $108,000. However, Han Products has determined that 30% of the fixed overhead being applied to part S-6 will be avoided if part S-6 is purchased from the outside supplier.
2. What is the annual rental value at which the company will be indifferent between the two options? (Round "Total costs" and final answer to the nearest whole dollar amount.)
To determine the annual rental value at which the company will be indifferent between manufacturing part S-6 in-house or purchasing it from the outside supplier, we need to compare the total costs of both options.
First, let's calculate the total cost of manufacturing part S-6 in-house:
Total cost per part = Direct materials + Direct labor + Variable overhead + Fixed overhead
Total cost per part = $6.50 + $12.50 + $5.50 + $10.80
Total cost per part = $35.30
Total cost of manufacturing in-house = Total cost per part * Number of units manufactured
Total cost of manufacturing in-house = $35.30 * 60,000 units
Total cost of manufacturing in-house = $2,118,000
Now, let's calculate the total cost of purchasing part S-6 from the outside supplier:
Total cost of purchasing = Purchase price per part * Number of units purchased
Total cost of purchasing = $31.00 * 53,000 units
Total cost of purchasing = $1,643,000
Next, let's consider the avoided fixed overhead by purchasing from the outside supplier:
Avoided fixed overhead = 30% of the fixed overhead applied to part S-6 * Number of units purchased
Avoided fixed overhead = 0.30 * $10.80 * 53,000 units
Avoided fixed overhead = $163,080
Finally, let's calculate the annual rental value that would make the company indifferent between the two options:
Annual rental value = Total cost of manufacturing in-house - Total cost of purchasing + Avoided fixed overhead
Annual rental value = $2,118,000 - $1,643,000 + $163,080
Annual rental value = $638,080
Therefore, the annual rental value at which the company will be indifferent between the two options is $638,080.