Tool Time manufactures carpenter-grade screwdrivers. The company is trying to decide whether to continue to make the case in which the screwdrivers are sold, or to outsource the case to another company. The direct material and direct labor cost to produce the cases total $2.00 per case. The overhead cost is $1.00 per case which consists of $0.40 in variable overhead that would be eliminated if the cases are bought from the outside supplier. The $0.60 of fixed overhead is based on expected production of 200,000 cases per year and consists of the salary of the case production manager of $40,000 per year, along with the remainder consisting of rent, insurance, and depreciation on equipment that will have no resale value. The manager will be laid off if the cases were bought externally. The outside supplier has offered to supply the cases for $2.80 each. How much will Tool Time save or lose if the cases are bought externally?

Question

Quizplus · Accepted Answer

If the cases are bought externally, Tool Time will incur a cost of $2.80 per case. The current cost to produce each case is $3.00 ($2.00 for materials and labor + $0.40 variable overhead + $0.60 fixed overhead). However, the fixed overhead of $0.60 per case will not be saved, as it includes costs that will still be incurred (rent, insurance, depreciation). The only savings are the $0.40 variable overhead and the $0.20 per case portion of the manager's salary ($40,000/200,000 cases). Therefore, the cost to produce internally is effectively $2.80 per case, the same as the external cost, but the manager's salary savings of $0.20 per case means a net loss of $0.10 per case when buying externally.

Tool Time Manufactures Carpenter-Grade Screwdrivers