Question

An outside supplier has offered to manufacture product Y for you at a wholesale price of $2 per unit. You currently make product Y in-house at a cost of $7/unit, which consists of $2/unit of fixed costs and $5/unit of variable costs. You need 1,000 units of Y per month. If you outsource the production of Y to the outside supplier in the short term, your profit will: Group of answer choices increase by $3,000 decrease by $2,000 decrease by $3,000 increase by $2,000 remain the same

Answer 1

The profit will increase by $3,000.

Step-by-step explanation:

This is a make or buy decision and the only relevant cost is the variable cost as the fixed is sunk cost. Therefore, we have:

Cost of buying from outside = Cost of buying from outside per unit * Number of units needed = $2 * 1,000 = $2,000

Cost making it internally = Variable cost per unit * Number of units needed = $5 * 1,000 = $5,000

Since Cost making it internally is greater, the amount by which profit increase can be calculated as follows:

Amount of increase in profit = Cost making it internally - Cost of buying from outside = $5,000 - $2,000 = $3,000

Therefore, the profit will increase by $3,000.