Melbourne Corporation has traditionally made a subcomponent of its major product. Annual production of 30,000 subcomponents results in the following costs: Melbourne has received an offer from an outside supplier who is willing to provide the 30,000 units of the subcomponent each year at a price of $28 per unit. Melbourne knows that the facilities now being used to manufacture the subcomponent could be rented to another company for $80,000 per year if the subcomponent were purchased from the outside supplier. There would be no effect of this decision on the total fixed manufacturing overhead of the company. Assume that direct labor is a variable cost.If Melbourne decides to purchase the subcomponent from the outside supplier, the annual financial advantage (disadvantage) would be:
A) $120,000
B) $20,000
C) ($120,000)
D) ($20,000)

Question

Melbourne Corporation has traditionally made a subcomponent of its major product. Annual production of 30,000 subcomponents results in the following costs:  Melbourne has received an offer from an outside supplier who is willing to provide the 30,000 units of the subcomponent each year at a price of $28 per unit. Melbourne knows that the facilities now being used to manufacture the subcomponent could be rented to another company for $80,000 per year if the subcomponent were purchased from the outside supplier. There would be no effect of this decision on the total fixed manufacturing overhead of the company. Assume that direct labor is a variable cost.If Melbourne decides to purchase the subcomponent from the outside supplier, the annual financial advantage (disadvantage) would be:
A) $120,000 
B) $20,000 
C) ($120,000) 
D) ($20,000)

Quizplus · Accepted Answer

The annual cost to manufacture 30,000 subcomponents is as follows:

Direct Materials: $342,000
Direct Labor: $90,000
Variable Manufacturing Overhead: $48,000
Fixed Manufacturing Overhead: $360,000 ($12 per unit)

Total Cost: $840,000
Cost per unit: $28 ($840,000/30,000 units)

If Melbourne purchases the subcomponent from the outside supplier, the annual cost would be:

Purchase price: $28 per unit
Total cost: $840,000 ($28 x 30,000 units)

If Melbourne purchases the subcomponent from the outside supplier, it would be able to rent out its facilities for $80,000 per year. However, this would have no effect on the total fixed manufacturing overhead of the company.

The annual financial advantage/disadvantage of purchasing the subcomponent from the outside supplier is:

Total cost of purchasing subcomponent: $840,000
Less: Renting out facilities: ($80,000)
Net cost: $760,000

Melbourne would save $80,000 per year by purchasing the subcomponent from the outside supplier, but this is more than offset by the higher cost of purchasing the subcomponent. Therefore, the annual financial disadvantage of purchasing the subcomponent from the outside supplier is $80,000 + ($760,000 - $840,000) = $120,000.

Melbourne Corporation Has Traditionally Made a Subcomponent of Its Major