Lincoln Company produces a part that is used in the manufacture of one of its products. The unit manufacturing costs of this part, assuming a production level of 5,000 units, are as follows:
$$\begin{array} { | l | r | r | }
\hline \text { Direct materials } & \$ 3 & \
\hline \text { Direct labor } & 5 & \
\hline \text { Variable manufacturing overhead } & 4 & \
\hline \text { Fixed manufacturing overhead } & 2 & \
\hline \text { Total cost } & \$ 14 & \
\hline
\end{array}$$ The fixed overhead costs are unavoidable.
Assuming Lincoln Company can purchase 5,000 units of the part from Sexton Company for $15 each, and the facilities currently used to make the part could be rented out to another manufacturer for $20,000 a year, what should Lincoln Company do?

Question

Lincoln Company produces a part that is used in the manufacture of one of its products. The unit manufacturing costs of this part, assuming a production level of 5,000 units, are as follows:
$$\begin{array} { | l | r | r | } 
\hline \text { Direct materials } & \$ 3 & \
\hline \text { Direct labor } & 5 & \
\hline \text { Variable manufacturing overhead } & 4 & \
\hline \text { Fixed manufacturing overhead } & 2 & \
\hline \text { Total cost } & \$ 14 & \
\hline
\end{array}$$ The fixed overhead costs are unavoidable.
Assuming Lincoln Company can purchase 5,000 units of the part from Sexton Company for $15 each, and the facilities currently used to make the part could be rented out to another manufacturer for $20,000 a year, what should Lincoln Company do?

Quizplus · Accepted Answer

The cost to make the part is $14 per unit, which includes $2 of fixed costs that are unavoidable. If Lincoln buys the part for $15, it seems at first glance they are spending $1 more per unit. However, by not using their facilities to make the part, they can rent out the space for $20,000 a year. The opportunity cost of not renting out the space should be considered as part of the cost to make the part. The total cost to make 5,000 units is $70,000 ($14/unit * 5,000 units), but when considering the opportunity to earn $20,000 from renting out the space, the effective cost of making the part increases. Therefore, buying the part actually saves money when considering the opportunity cost of $20,000, which effectively reduces the cost difference and makes buying the part the cheaper option when considering the broader financial impact.

Lincoln Company Produces a Part That Is Used in the Manufacture