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Please explain if i need to multiply the make and buy amounts by sold 20,000 units or manufactured 20,000 units. And why? That's it. Thank you.

Exercise 10-12 Make or Buy a Component [LO3]

Royal Company manufactures 20,000 units of part R-3 each year for use on its production line. At this level of activity, the cost per unit for part R-3 is:

Direct materials	$	4.80
Direct labor		7.00
Variable manufacturing overhead		3.20
Fixed manufacturing overhead		10.00
Total cost per part	$	25.00

An outside supplier has offered to sell 20,000 units of part R-3 each year to Royal Company for $23.50 per part. If Royal Company accepts this offer, the facilities now being used to manufacture part R-3 could be rented to another company at an annual rental of $150,000. However, Royal Company has determined that $6 of the fixed manufacturing overhead being applied to part R-3 would continue even if part R-3 were purchased from the outside supplier.

Required:

a.	What is the total relevant cost of making the product?

Total relevant cost of making the product (20,000 units)

$

b.	What is the total relevant cost of buying the product?

Total relevant cost of buying the product (20,000 units)

$

c.	What is the opportunity cost of making instead of buying?

Total opportunity cost

$

d.	How much profits will increase or decrease if the outside suppliers offer is accepted? (Input the amount as a positive value.)

Profits would increase by

$

Explanation:

The costs that can be avoided as a result of purchasing from the outside are relevant in a make-or-buy decision. The analysis is:

	Per Unit Differential Costs					20,000 Units
	Make			Buy		Make		Buy
Cost of purchasing				$	23.50			$	470,000
Cost of making:
Direct materials	$	4.80				$	96,000
Direct labor		7.00					140,000
Variable manufacturing overhead		3.20					64,000
Fixed manufacturing overhead		4.00	*				80,000
Total cost	$	19.00		$	23.50	$	380,000	$	470,000

*The remaining $6 of fixed manufacturing overhead cost would not be relevant because it will continue regardless of whether the company makes or buys the parts.

The $150,000 rental value of the space being used to produce part R-3 is an opportunity cost of continuing to produce the part internally. Thus, the complete analysis is:

	Make		Buy
Total cost, as above	$	380,000	$	470,000
Rental value of the space (opportunity cost)		150,000
Total cost, including opportunity cost	$	530,000	$	470,000
Net advantage in favor of buying		$60,000

Profits would increase by $60,000 if the outside suppliers offer is accepted.

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