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:
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?
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.
To determine whether Monash should make or buy part Z911, we need to compare the costs of producing it internally with the cost of purchasing it from an outside supplier.
1. Should Monash make or buy part Z911? Justify:
a) Current Scenario:
- The cost per unit for Z911 is $18.50, which includes direct materials, direct labor, variable overhead, and fixed overhead.
- The fixed overhead assigned to Z911 consists of $88,000 direct fixed overhead and the remaining as common fixed overhead.
- Monash currently produces 40,000 units annually.
b) Make Decision:
- The total fixed overhead assigned to Z911 is $88,000 + (remaining common fixed overhead).
- The total cost of producing Z911 internally is (40,000 units) x ($18.50 per unit) + (fixed overhead).
- Compare the cost of producing internally with the outside supplier's selling price to determine whether Monash should make or buy.
2. What is the most Monash would be willing to pay an outside supplier?
- Monash should be willing to pay an amount equal to or less than the cost of producing Z911 internally. This can be calculated by dividing the total cost of producing internally by the number of units (40,000 units).
3. If Monash bought the part, by how much would income increase or decrease?
- Calculate the income increase or decrease by comparing the difference between the current scenario and if Monash bought the part at the maximum price calculated in point 2.
To determine whether Monash should make or buy part Z911, let's calculate the relevant costs and compare them.
1. Should Monash make or buy part Z911?
To make an informed decision, we need to compare the costs of making the part in-house with the cost of buying it from an outside supplier.
For making the part in-house, the cost per unit is $18.50, which includes direct materials, direct labor, variable overhead, and fixed overhead. However, we need to exclude the direct fixed overhead of $88,000 since it will not be incurred if the line is dropped.
The cost per unit for Z911, excluding the direct fixed overhead, is as follows:
Direct Materials: $9.00
Direct Labor: $3.00
Variable Overhead: $2.50
Fixed Overhead (common): $4.00
Total: $18.50 - $4.00 (fixed overhead excluded) = $14.50
However, if Monash chooses to buy the part from the outside supplier, the cost per unit is $16.
Comparing the costs:
- In-house cost: $14.50 per unit
- Outside supplier cost: $16 per unit
Since the cost of buying from the outside supplier is less than the in-house cost, Monash should choose to buy part Z911.
2. What is the most Monash would be willing to pay an outside supplier?
If Monash decides to buy the part from the outside supplier, they would be willing to pay up to their in-house cost per unit, which is $14.50. Therefore, the most Monash would be willing to pay an outside supplier is $14.50 per unit.
3. If Monash bought the part, by how much would income increase or decrease?
If Monash bought the part instead of making it, their income would decrease by the difference between the in-house cost per unit and the cost per unit from the outside supplier. In this case, the difference is $14.50 - $16 = -$1.50 (a decrease of $1.50 per unit). The income would decrease by $1.50 multiplied by the annual production of 40,000 units.
Now, let's consider the scenario where all of the fixed overhead is common fixed overhead.
1. Should Monash make or buy part Z911?
If all of the fixed overhead is common fixed overhead, it means that the lease of production machinery and salary of the production line supervisor are not specific to producing part Z911. Therefore, we should consider the cost per unit without excluding any fixed overhead.
The cost per unit for Z911, including all fixed overhead as common fixed overhead, is $18.50.
Comparing this cost with the outside supplier's cost per unit of $16, we can see that Monash should still choose to buy part Z911.
2. What is the most Monash would be willing to pay an outside supplier?
If Monash decides to buy the part, the most they would be willing to pay an outside supplier is their in-house cost per unit, which is $18.50.
3. If Monash bought the part, by how much would income increase or decrease?
If Monash bought the part from the outside supplier, their income would decrease by the difference between the in-house cost per unit ($18.50) and the cost per unit from the outside supplier ($16). Hence, the income would decrease by $2.50 per unit. The total income decrease would be $2.50 multiplied by the annual production of 40,000 units.