Question

Fornelli Inc. can produce 100 units of a component part with the costs listed below. If Fornelli can purchase the component part externally for $44,000 and only 4000 of the fixed costs can be avoided, what is the correct make or buy decision?

Direct materials: $15,000
Direct labor: $6500
Variable overhead: $16,000
Fixed overhead: $11,000

Answer 1

After analyzing costs, Fornelli Inc. should choose to buy the component part externally as it is cheaper by $500 than producing it in-house.

Step-by-step explanation:

Fornelli Inc. is faced with a decision on whether to produce a component part in-house or to purchase it externally. To resolve this, we must compare the total internal production cost with the external purchase cost. Let's calculate the internal production costs first:

Direct materials: $15,000

Direct labor: $6,500

Variable overhead: $16,000

Fixed overhead (only $4,000 can be avoided): $11,000 - $4,000 = $7,000

The total internal production cost is:

$15,000 (Direct materials) + $6,500 (Direct labor) + $16,000 (Variable overhead) + $7,000 (Non-avoidable fixed overhead) = $44,500

The external purchase cost is $44,000. Comparing $44,500 (internal production) to $44,000 (external purchase), Fornelli Inc. would save $500 by purchasing the component externally. Therefore, the correct make or buy decision would be to buy the component part.