Zitner Corp. makes 47,500 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows:

Zitner Corp. makes 47,500 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows:

Direct material                                    $16.00

Direct labor                                         18.50

Variable manufacturing overhead           5.50

Fixed manufacturing overhead             23.00
Unit product cost                                $63.00

An outside supplier has offered to sell the company all of the 47,500 parts it needs for $59.00 a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be $275,000 per year. If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, 65% of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the company’s remaining products.

Using Microsoft Word or Excel, please answer the following questions:

1. How much of the unit product cost of $63.00 is relevant in the decision of whether to make or buy the part?

A. What is the net total dollar advantage (disadvantage) of purchasing the part rather than making it?

B. Should Zitner continue to manufacture the part or buy it?

C. What effect do fixed costs have on the answer you gave for B?

2. What would have to happen to fixed costs for your answer to 1-B to be different?

3. What is the maximum amount the company should be willing to pay an outside supplier per unit for the part if the supplier commits to supplying all 47,500 units required each year?

Expert Answer

 

  1. How much of the unit product cost of $63.00 is relevant in the decision of whether to make or buy the part?

Saving in direct labor cost=$18.50

Saving in fixed manufacturing overhead cost=(100-65)=35%

Saving in fixed manufacturing overhead cost=0.35*23=$8.05

Saving in direct material cos=$16.00

Saving in variable overhead=$5.50

Total product cost relevant for decision making=(18.5+8.05+16+5.5)=$48.05

1A.Net Dollar Dis Advantage: Saving in cost if manufacturing is discontinue=47500*48.05=

$ 2,282,375

Cost of purchase=47500*59= $ (2,802,500)

Additional contribution from other product=$275,000

Net disadvantage=$2802500-$2282375-$275000=$245,125

Saving from discontinued production $        2,282,375
Cost of purchase $      (2,802,500)
Additional contribution by use of facilities $275,000
Net savings $         (245,125)

1B.Zinter should continue to manufacture the part

1C. Effect of Fixed cost: If fixed cost could be save more than 60% (instead of 35%) if production is discontinued, the decision would have been to buy the product.

If further saving in fixed cost is more than($245125/47,500=$5.2 ) per unit for discontinuation of production, the decision would be to buy the product

  1. For the answer to be different, the saving in fixed cost for discontinued operation should be =Current saving of 35%(=$8.05)+$5.2 further saving=$13.25

After discontinuation of operation only (23-13.25)=$9.75 per part should continue to be incurred. Or instead of 65%, (9.75/23=)42.4% should be continued and balance saved.

  1. Maximum amount to be paid to suppler:

With the current price of $59, Net loss=$245,125

Maximum amount that can be paid=$59-(245125/47500)=$59-$5.16=$53.84

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