Gottshall Inc. makes a range of products. The company’s predetermined overhead rate is $19 per
direct labor-hour, which was calculated using the following budgeted data:
Variable manufacturing overhead $ 225,000
Fixed manufacturing overhead $ 630,000
Direct labor-hours 45,000. Component P0 is used in one of the company’s products. The unit cost of the component according to
the company’s cost accounting system is determined as follows:
Direct materials $ 21.00
Direct labor 40.80
Manufacturing overhead applied 32.30
Unit product cost $ 94.10
An outside supplier has offered to supply component P0 for $78 each. The outside supplier is known
for quality and reliability. Assume that direct labor is a variable cost, variable manufacturing overhead
is really driven by direct labor-hours, and total fixed manufacturing overhead would not be affected
by this decision. Gottshall chronically has idle capacity.
Required:
Is the offer from the outside supplier financially attractive? Explain why?