ABC Company would like to purchase a particular item from a potential supplier.
ID: 2472152 • Letter: A
Question
ABC Company would like to purchase a particular item from a potential supplier. ABC does not know the supplier’s specific cost structure for producing this item, but hope to estimate the cost using some information gathered from the supplier. After a couple of meetings with the supplier, ABC is able to gather the following information.
If the purchase price is $12, the supplier requires at least 6,000 units to avoid a loss (break-even).
If the purchase price is $15, the supplier requires at least 4,000 units to avoid a loss (break-even).
The supplier’s SGA expense (selling, general, administrative) is estimated to be $1.5 per unit.
The supplier’s direct material cost is estimated to be $2 per unit.
The supplier’s material to labor ratio is estimated to be 1.25.
ABC finally agrees to pay $12 per unit and anticipates a volume of 8,000 in the upcoming year. Based on the information above, answer the following questions.
1. Using the break-even analysis technique, identify the supplier’s fixed and variable cost for producing this item. (Assuming the variable cost increases linearly with the purchase volume)
Explanation / Answer
Assume that the unit variable cost =k At 6000 unit Break vene level: Unit Sales Price= 12.00 Unit variable cost = k Unit contribution margin =12-k Total Contribution margin=6000(12-k)=fixed cost At 4000 unit Break vene level: Unit Sales Price= 15.00 Unit variable cost = k Unit contribution margin =15-k Total Contribution margin=4000(15-k)=fixed cost So , 6000(12-k)=4000(15-k) 72000-6000k=60000-4000k 2000k=12000 k=6 So unit Variable cost =6 At 6000 units level: Total Contribution =6000(12-k)-= fixed cost So Fixed cost=36000 So the cost structure of the supplier is : 1. Variable cost per unit =$6 2. Fixed cosr per period =$36000