Problem 5 ABC Company makes key chains The total cost to mak

Problem 5. ABC Company makes key chains. The total cost to make 1,000,000 key chains is as follows: Material.$160,000 Labor. Indirect costs: $60,000 Variable...$120,000 Fixed.. Total Cost.$510,000 $170,000 The XYZ Company has offered to make the chains for $.40. If ABC Co.purchases the key chains from XYX Co. 40% of the fixed costs will be avoided. The remaining 60% will continue regardless of whether the key chains are manufactured or purchased. If the key chains are purchased the capacity currently used to make the key chains will be idle. In turn, the idle capacity can be leased out resulting in additional contribution of $50,000 with a related maintenance cost to ABC Co. of $20,000. Required: 1.How much would ABC save or lose by buying the key chains from XYZ?

Solution

The relevant benefits and costs are: Benefits: Savings in costs: Material 160000 Labor 60000 Variable overhead 120000 Fixed overhead = 170000*40% = 68000 Total savings in costs 408000 Lease income (50000-20000) 30000 Total benefits 438000 Total cost of purchase = 1000000*0.40 = 400000 Net savings by buying key chains 38000