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Relevant Costs for Decision Making

1. Frogers Company makes 40,000 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 materials $23.40
Direct labor 22.30
Variable manufacturing overhead 1.40
Fixed manufacturing overhead 24.60
Unit product cost $71.70

An outside supplier has offered to sell the company all of these parts it needs for $59.20 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 $352,000 per year.

If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, $21.90 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.

a. How much of the unit product cost of $71.70 is relevant in the decision of whether to make or buy the part? (2 points)
b. What is the net total dollar advantage (disadvantage) of purchasing the part rather than making it? (2 points)
c. 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 40,000 units required each year? (2 points)

2. Pilsbury Corporation makes a range of products. The company's predetermined overhead rate is $23 per direct labor-hour, which was calculated using the following budgeted data:

Variable manufacturing overhead $200,000
Fixed manufacturing overhead $375,000
Direct labor-hours 25,000

Management is considering a special order for 800 units of product N89E at $69 each. The normal selling price of product N89E is $88 and the unit product cost is determined as follows:

Direct materials $28.00
Direct labor 22.50
Manufacturing overhead applied 34.50
Unit product cost $85.00

If the special order were accepted, normal sales of this and other products would not be affected. The company has ample excess capacity to produce the additional units. Assume that direct labor is a variable cost, variable manufacturing overhead is really driven by direct labor-hours, and total fixed manufacturing overhead would not be affected by the special order.

If the special order were accepted, what would be the impact on the company's overall profit? (5 points)

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