StudentCost08 - Measuring relevant costs and revenues for...

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a) (£) Purchase price of component from supplier 50 Additional cost of manufacturing (variable cost only) 34 –– Saving if component manufactured 16 –– The component should be manufactured provided the following assumptions are correct: (i) Direct labour represents the additional labour cost of producing the component. (ii) The company will not incur any additional fixed overheads if the component is manufactured. (iii) There are no scarce resources. Therefore the manufacture of the component will not restrict the production of other more profitable products. (b) (i) Additional fixed costs of £56 000 will be incurred, but there will be a saving in purchasing costs of £16 per unit produced. The break-even point is 3500 units (fixed costs of £56 000 / £16 per unit saving). If the quantity of components manufactured per year is less than 3500 units then it will be cheaper to pur- chase from the outside supplier. (ii) The contribution per unit sold from the existing product is £40 and each unit produced uses 8 scarce labour hours. The contribution per labour hour is £5. Therefore if the component is manufactured, 4 scarce labour hours will be used, resulting in a lost contribution of £20. Hence the relevant cost of manufacturing the components is £54, consisting of £34 incremental cost plus a lost contribution of £20. The component should be purchased from the supplier. (c) The book value of the equipment is a sunk cost and is not relevant to the decision whether the company should purchase or continue to manufacture the components. If we cease production now, the written-down value will be written off in a lump sum, whereas if we continue production, the written- down value will be written off over a period of years. Future cash outflows on the equipment will not be affected by the decision to purchase or continue to
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This note was uploaded on 10/20/2009 for the course ACCT 333 taught by Professor Shirin during the Spring '09 term at École Normale Supérieure.

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StudentCost08 - Measuring relevant costs and revenues for...

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