Question

Gelb Company currently manufactures 52,500 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 $65,000 per year, and allocated fixed costs are $75,500 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 52,500 units and buying 52,500 units. Should it continue to manufacture the component, or should it buy this component from the outside supplier

Answer 1

Gelb Company should choose to Buy the Component since it is the cheaper option. This gives a cost advantage of $28,875.

Step-by-step explanation:

For each Option, include costs which are unavoidable because those would change as a result of this decision, they are relevant costs items.

Total incremental cost : Making

Variable costs (52,500 x $4.05) $212,625

Fixed Costs (unavoidable) $75,500

Total $288,125

Total incremental cost : Buying

Purchase Price ( 52,500 x $3.50) $183,750

Fixed Costs (unavoidable) $75,500

Total $259,250

Conclusion :

Gelb Company should choose to Buy the Component since it is the cheaper option. This gives a cost advantage of $28,875 ($288,125 - $259,250).