Penagos Corporation is presently making part Z43 that is used in one of its products. A total of 5,000 units of this part are produced and used every year. The company's Accounting Department reports the following costs of producing the part at this level of activity:
| Per Unit | ||
| Direct materials | $ | 1.10 |
| Direct labor | $ | 3.10 |
| Variable overhead | $ | 6.90 |
| Supervisor's salary | $ | 5.80 |
| Depreciation of special equipment | $ | 5.20 |
| Allocated general overhead | $ | 5.60 |
An outside supplier has offered to produce and sell the part to the company for $20.80 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company. If the outside supplier's offer were accepted, only $4,000 of these allocated general overhead costs would be avoided.
In addition to the facts given above, assume that the space used to produce part Z43 could be used to make more of one of the company's other products, generating an additional segment margin of $24,000 per year for that product. What would be the annual financial advantage (disadvantage) of buying part Z43 from the outside supplier and using the freed space to make more of the other product?
Multiple Choice
Explanation
| Make | Buy | |||||
| Direct materials (5,000 units × $1.10 per unit) | $ | 5,500 | ||||
| Direct labor (5,000 units × $3.10 per unit) | 15,500 | |||||
| Variable overhead (5,000 units × $6.90 per unit) | 34,500 | |||||
| Supervisor's salary (5,000 units × $5.80 per unit) | 29,000 | |||||
| Depreciation of special equipment (not relevant) | 0 | |||||
| Allocated general overhead (avoidable only) | 4,000 | |||||
| Outside purchase price (5,000 units × $20.80 per unit) | $ | 104,000 | ||||
| Opportunity cost | (24,000 | ) | ||||
| Total cost | $ | 88,500 | $ | 80,000 | ||
Buying the part rather than making it would decrease total cost by $8,500 per year.
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