The Pleasantville Company makes 20,000 units per year of a part used in production. The unit product cost is as follows: An outside supplier has offered to sell the company the same part at a cost of $9.00 per unit. If the company purchases the part only half of the fixed overhead would be avoided. How much of the unit product cost is relevant in making this decision?

Question

The Pleasantville Company makes 20,000 units per year of a part used in production. The unit product cost is as follows:  An outside supplier has offered to sell the company the same part at a cost of $9.00 per unit. If the company purchases the part only half of the fixed overhead would be avoided. How much of the unit product cost is relevant in making this decision?

Quizplus · Accepted Answer

The relevant cost in this decision is the incremental cost of purchasing the part from the outside supplier compared to the cost of producing it in-house. The incremental cost is calculated as the difference between the cost of purchasing the part and the variable cost per unit of producing it in-house, plus half of the fixed overhead per unit:

Incremental cost = ($9.00 – $7.60) + ($2.40/2) = $1.40 + $1.20 = $2.60

Therefore, the relevant cost is $10.10 – $2.60 = $7.50 per unit. Since the outside supplier is selling the same part at a cost of $9.00 per unit, it is not beneficial for the Pleasantville Company to purchase the part from the outside supplier.

The Pleasantville Company Makes 20,000 Units Per Year of a Part