Item Expense Direct materials $60,000 Direct labor $180,000 Variable overhead (power and water). Fixed overhead (light and heat) $135,000 $70,000 Total cost $445,000
Santa Fe Company, a farm-equipment manufacturer, currently produces 20,000 units of gas filters for use in its lawnmower production annually. The following costs are reported according to the previous year's production:
It is anticipated that gas-filter production will last five years. If the company continues to produce the product in-house, annual direct-material costs will increase at a rate of 5%. (For example, the annual direct-material costs during the first production year will be $63,000.) In addition, direct-labor costs will increase at a rate of 6% per year, and variable-overhead costs will increase at a rate of 3% while fixed-overhead costs will remain at the current level over the next five years. Tompkins Company has offered to sell Santa Fe Company 20,000 units of gas filters for $25 per unit. If Santa Fe accepts the offer, some of the facilities currently used to manufacture the gas filters could be rented to a third party at an annual rate of $35,000. In addition, $3.50 per unit of the fixed-overhead costs applied to gas-filter production would be eliminated. The firm's interest rate is known to be 15%. What is the unit cost of buying the gas filters from the outside source? Should Santa Fe accept Tompkins's offer? Why or why not?
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