Question

Gelb Company currently manufactures 56,500 units per year of a key component for its manufacturing process. Variable costs are $4.05 per unit, fixed costs related to making this component are $85,000 per year, and allocated fixed costs are $78,500 per year. The allocated fixed costs are unavoidable whether the company makes or buys this component. The company is considering buying this component from a supplier for $3.50 per unit. Calculate the total incremental cost of making 56,500 units and buying 56,500 units. Should it continue to manufacture the component, or should it buy this component from the outside supplier

Answer 1

Incremental Costs to Make

Variable Cost Per Unit = $4.05 = 56,500 units*$4.05 = $228,825

Fixed Manufacturing Costs = $85,000

Total Incremental Costs to Make $313,825

Incremental Costs to Buy

Purchase Price Per Unit = $3.50 = 56,500 unit*$3.50 = $197,750

Total Incremental Cost to Buy = $197,750

The company should buy the component from outside supplier as it results in a lower total incremental cost of $197,750