For Several Years,Patel Division Has Produced an Electronic Component That

question 130

Essay

For several years,Patel Division has produced an electronic component that it sells to Morrison Division at the prevailing market price of $27.Patel manufactures the component only for Morrison Division and has previously made no sales of this product to outside customers.The product is available from independent suppliers who would charge the Morrison Division $27 per unit.Patel Division currently produces and sells 30,000 of these components each year and also manufactures several other products.The following annual cost information was compiled after the close of 2010 operations,during which time Patel Division operated at full capacity:
$\begin{array}{lr}& \text { Cost per } \\\text { Patel Division (2010) } &\text { Component }\\\text { Direct materials } & \$ 9.00 \\\text { Direct labor (hourly basis) } & 11.20 \\\text { Variable overhead } & 5.00 \\\text { General fixed overhead of plant } & 12.40 \\\text { Traceable fixed overhead }(\$ 90,000 \div 30,000) & 3.00 \\\text { Variable shipping expenses } & 1.00 \\\text { Total unit cost } & \$ 41.60 \\\end{array}$
General fixed overhead represents allocated joint fixed costs such as building depreciation,property taxes,and salaries of production executives.If production of the components were discontinued,$72,000 of the annual traceable fixed overhead could be eliminated.The costs to be saved currently require cash outlays; the balance of traceable fixed overhead is equipment depreciation on machinery that could be used elsewhere in the plant.
a. Compute the incremental cost per unit of this product manufactured by Patel Division.
b. The division manager contends that producing the components to accommodate other divisions is a sound policy as long as variable costs are recovered by sales. Should Patel Division continue to produce the components for Morrison Division?

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Definitions:

Economic Rent

A payment to an owner or factor of production in excess of the costs needed to bring that factor into production.

Marginal Revenue Product

The additional revenue generated from using one more unit of a factor of production.

Wages

Payments made to employees for their labor, typically calculated on an hourly, daily, or piecework basis.

Economic Rent

The excess payment made to a factor of production over and above what would be needed to keep it in its current use.