Question

Exercise 10-2 Make or buy LO P1 Gelb Company currently manufactures 40,000 units per year of a key component for its manufacturing process. Variable costs are $1.95 per unit, fixed costs related to making this component are $65,000 per year, and allocated fixed costs are $58,500 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 40,000 units and buying 40,000 units. Should it continue to manufacture the component, or should it buy this component from the outside supplier?

Answer 1

Buy

Step-by-step explanation:

Allocated fixed costs are irrelevant for this decision because they can not be avoided, regardless of the alternatives being considered.

Making

Variable Cost ($1.95×40,000 units) $78,000

Fixed Costs $65,000

Total $143,000

Buying

Price ($3.50×40,000 units) $140,000

It costs $3,000 more to make the component than to buy from outside supplier.

Therefore, buy this component from the outside supplier