Cotton Corp.currently makes 10,000 subcomponents a year in one of its factories.The unit costs to produce are: An outside supplier has offered to provide Cotton Corp.with the 10,000 subcomponents at an $84.50 per unit price.Fixed overhead is not avoidable.What is the maximum price Cotton Corp.should pay the outside supplier?
A)$65.00
B)$84.50
C)$91.00
D)$58.50

Question

Cotton Corp.currently makes 10,000 subcomponents a year in one of its factories.The unit costs to produce are:  An outside supplier has offered to provide Cotton Corp.with the 10,000 subcomponents at an $84.50 per unit price.Fixed overhead is not avoidable.What is the maximum price Cotton Corp.should pay the outside supplier?
A)$65.00 
B)$84.50 
C)$91.00 
D)$58.50

Quizplus · Accepted Answer

Cotton Corp should compare its current cost of producing 10,000 subcomponents with its fixed overhead cost to the cost of buying the subcomponents from the outside supplier. The total cost of producing 10,000 subcomponents is:
Total cost = (Variable cost per unit x Number of units) + Fixed overhead
Total cost = (11 x 10,000) + Fixed overhead
The offer from the outside supplier is $84.50 per unit, so the total cost of buying 10,000 subcomponents is:
Total cost = (84.50 x 10,000)
To determine the maximum price Cotton Corp should pay the outside supplier, we need to set the two total cost equations equal to each other and solve for the price:
(11 x 10,000) + Fixed overhead = (84.50 x 10,000)
110,000 + Fixed overhead = 845,000
Fixed overhead = 735,000
Total cost = (Variable cost per unit x Number of units) + Fixed overhead
Total cost = (Variable cost per unit x 10,000) + 735,000
Total cost = (Variable cost per unit x 10,000) + 735,000
Therefore, Cotton Corp should pay a maximum price of $65.00 per unit ($84.50 - $19.50) to the outside supplier in order to break even. Option A is the correct answer.