Sewtfi861 Corporation makes an extra large part to use in one its fabulous products. A total of 16,000 units of this extra large part are produced and used every year. The company's costs of producing the extra large part at this level of activity are below: Per Unit
Direct materials $3.50
Direct labor $8.10
Variable manufacturing overhead $8.60
Supervisor's salary $4.00
Depreciation of special equipment $2.40
Allocated general overhead $7.60

An outside supplier has offered to make the extra large part and sell it to Sewtfi861 for $32.70 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including the direct labor, can be avoided. The special equipment used to make the extra large part has no salvage value or other use. The allocated general overhead represents fixed costs of the entire Sewtfi861 company, none of which would be avoided if the part were purchased instead of produced internally. In addition, the space used to make the extra large part could be used to make more of one of the company's other fabulous products, generating an additional segment margin of $35,000 per year for that product.

Required:
What would be the annual financial advantage (disadvantage) for Sewtfi861 Corp. as a result of buying the extra large part from the outside supplier?

Sewtfi861 Corporation

The annual financial disadvantage for Sewtfi861 Corporation buying the extra large part from the outside supplier would be:

$101,000.

Explanation:

a) Data and Calculations:

Cost implications:

                                                        In-house          Outside

                                                       Production      Production

Outside vendor's price                                             $32.70

Direct materials                                 $3.50

Direct labor                                         $8.10

Variable manufacturing overhead   $8.60

Supervisor's salary                           $4.00              

Depreciation of special equipment $2.40                $2.40

Allocated general overhead            $7.60               $7.60

Additional segment margin ($35,000/16,000)      ($2.1875)

Total cost per unit                         $34.20             $40.5125

The annual financial disadvantage for Sewtfi861 Corporation buying the extra large part from the outside supplier would be 16,000 ($40.5125 - $34.20).

= $101,000

b) It looks better financially for Sewtfi861 Corporation to continue to make the large part in-house.  If it goes ahead to buy the part from outside, it will suffer a total financial loss of $101,000 annually.

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