The Sands Company manufactures and sells several products, one of which is called a slip differential. The company normally sells 30,000 units of the slip differentials each month. At this activity level, unit costs are: Direct materials$4 Direct labor 3 Variable manufacturing overhead 4 Fixed manufacturing overhead 5 Variable selling 3 Fixed selling$1 An outside supplier has offered to produce the slip differentials for the Sands Company, and to ship them directly to the Sands Company's customers. This arrangement would permit the Sands Company to reduce its variable selling expenses by one third (due to elimination of freight costs). The facilities now being used to produce the slip differentials would be idle and fixed manufacturing overhead would continue at 60
percent of its present level. The total fixed selling expenses of the company would be unaffected by this decision.Required:What is the maximum acceptable price quotation for the slip differentials from the outside supplier?
What will be an ideal response?
The total cost savings from purchasing the slip differentials is $420,000 as computed below:
| Direct materials ($4 × 30,000) | $ | 120,000 | |
| Direct labor ($3 × 30,000) | 90,000 | ||
| Variable manufacturing overhead ($4 × 30,000) | 120,000 | ||
| Fixed overhead ($5 × 30,000 × 0.40) | 60,000 | ||
| Variable selling expense ($3 × 30,000 × 1/3) | 30,000 | ||
| Total relevant costs | $ | 420,000 |
$14 is the relevant cost figure. To be acceptable, the quotation received from the outside supplier must be less than $14.
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