King Parts Ltd has an annual production of 90,000 units for a motor component. The component’s cost structure is as follows:

Material per unit

270

Labour per unit (25% fixed)

180

Expenses per unit:

Variable

90

Fixed

135

225

Total cost per unit

675

  1. The purchase manager has an offer from a supplier who is willing to supply the component at Rs. 540. Should the component be purchased and production stopped?
  2. Assume the resources now used for this component’s manufacture are to be used to produce another new product for which the selling price is Rs. 485.

In the latter case, the material price will be Rs. 200 per unit. 90,000 units of this product can be produced at the same cost basis as above for labour and expenses. Discuss whether it would be advisable to divert the resources to manufacture that new product, on the footing that the component presently being produced would instead of being produced, be purchased from the market.