Question

Wilma Company must decide whether to make or buy some of its components. The costs of producing 60,000 switches for its generators are as follows.

Direct materials $29,000
Variable overhead $44,000
Direct labor $25,000
Fixed overhead $76,000
Instead of making the switches at an average cost of $2.90 ($174,000 ÷ 60,000), the company has an opportunity to buy the switches at $2.65 per unit. If the company purchases the switches, all the variable costs and one-fourth of the fixed costs will be eliminated.

Prepare an incremental analysis showing whether the company should make or buy the switches.

Answer 1

Wilma Company should produce internally as this will savings of $42,000.

Step-by-step explanation:

For a make or buy decision the relevant cash flows include

1. the differential variable of the two options

2. savings from avoidable fixed costs associated with internal production

Incremental analysis $

External cost of purchase($2.65 × 60,000) 159000

Variable cost - (29,000 + 44,000 + 25,000) = 98000

Extra variable cost of external purchase (61000 )

Savings in Avoidable fixed cost (1/4× 76,000) 19,000

Net extra cost of external purchase (42000 )

Wilma Company should produce internally as this will savings of $42,000.