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Homework answers / question archive / Auto Parts Limited has an annual production of 90,000 units for a motor component
Auto Parts Limited has an annual production of 90,000 units for a motor component. The component's cost structure is as follows: Particulars Value in Rupees per unit Materials 270 Labour (25% fixed) 180 Other Variable Expenses 90 Other Fixed Expenses 135 Total 675 (a) The purchase manager has an offer from a supplier who is willing to supply the component at Rs. 540. Should the component be purchased and production stopped/ (b) Assume the resources now used for this component's manufacture are to be used to produce another new product for which selling price is Rs. 485. In the latter case the material price will be Rs. 200 per unit. 90000 units of this product can be produced on the same cost basis as above for labour and expenses. Discuss whether it would be advisable to divert the resources to manufacture the new products, on the footing that the component presently being produced would, instead of being produced, be purchased from the market.
a. Relevant costs for decision making =Material + Variable labor cost + Variable expenses = 270+(180*75%)+90 = 495
The suppliers price is Rs.540 which is excess of the relevant costs for making the product. The fixed costs of Rs 180(45 +135) are not relevant in decision making since they will have to be incurred anyway i.e. irrespective of whether the product is made or bought from an outside supplier. Hence, the company should make the product than buying it since it is cheaper by Rs.45 [ 540- 495]
b. Contribution on the new product = Selling price - (Material + Variable labor cost + Variable expenses) = 485- (200+135+90) = 60
Lost contribution on purchasing the product from an outside supplier = 540 - 495 = 45
Net contribution gained = 60 - 45 =15
If the company diverts the resources towards the new product it will make a gain of Rs. 1350000 [ 90,000*15] and hence the component can be purchased from outside.
