Situation One

Toronto Corp. makes $64,000$ units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows:

Direct material $$22\mathrm{.}00$

Direct labor $25\mathrm{.}00$

Variable manufacturing overhead $7\mathrm{.}50$

Fixed manufacturing overhead $31\mathrm{.}00$

Unit product cost $$85\mathrm{.}50$

An outside supplier has offered to sell the company all of the $64,000$ parts it needs for $$79\mathrm{.}00$ a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be $$350,000$ per year. If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, $61\%$ of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the company's remaining products.