Cardinal Company needs 20,000 units of a certain part to use in one of its products.The following information is available: Oriole Company has offered to sell this part to Cardinal company for $36 each.If Cardinal buys the part from Oriole instead of making it,Cardinal would not have any use for the released capacity.In addition,60% of the fixed manufacturing overhead costs will continue regardless of what decision is made.Assume that direct labour is an avoidable cost in this decision.In deciding whether to make or buy the part,the total relevant costs to make the part are:
A) $560,000.
B) $640,000.
C) $720,000.
D) $760,000.

Question

Cardinal Company needs 20,000 units of a certain part to use in one of its products.The following information is available:  Oriole Company has offered to sell this part to Cardinal company for $36 each.If Cardinal buys the part from Oriole instead of making it,Cardinal would not have any use for the released capacity.In addition,60% of the fixed manufacturing overhead costs will continue regardless of what decision is made.Assume that direct labour is an avoidable cost in this decision.In deciding whether to make or buy the part,the total relevant costs to make the part are:
A) $560,000. 
B) $640,000. 
C) $720,000. 
D) $760,000.

Quizplus · Accepted Answer

The relevant costs to make the part are:
Direct Material Cost: 20,000 x $12 = $240,000
Direct Labor Cost: 20,000 x $10 = $200,000 (avoidable)
Variable Manufacturing Overhead Cost: 20,000 x $4 = $80,000
Total Variable Cost = $240,000 + $200,000 + $80,000 = $520,000
Total Relevant Cost = Total Variable Cost + Fixed Manufacturing Overhead Cost
= $520,000 + (60% of fixed manufacturing overhead cost)
= $520,000 + (0.6 x $240,000)
= $520,000 + $144,000
= $664,000

Therefore, the cost to make the part is $664,000, which is higher than the cost to buy the part from Oriole Company at $36 each, which is 20,000 x $36 = $720,000. Hence, it is economically feasible for Cardinal Company to buy instead of making the part.

Cardinal Company Needs 20,000 Units of a Certain Part to Use