Question

elb Company currently manufactures 50,000 units per year of a key component for its manufacturing process. Variable costs are $2.95 per unit, fixed costs related to making this component are $67,000 per year, and allocated fixed costs are $61,500 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 $3.90 per unit. Calculate the total incremental cost of making 50,000 units and buying 50,000 units. Should it continue to manufacture the component, or should it buy this component from the outside supplier

Answer 1

elb Company

a) Incremental Cost of making 50,000 units:

Variable costs = $2.95 x 50,000 = $147,500

Avoidable fixed costs = $67,000

Total = $214,500

b) Incremental Cost of buying 50,000

Buy-in costs =- $3.90 x 50,000 = $195,000

c) The company should buy this component from the outside supplier.

Step-by-step explanation:

In make or buy decisions, only variable and avoidable costs are taken into consideration. Unavoidable fixed costs are sunk costs which must be incurred irrespective of the choice made.

Therefore, the unavoidable allocated fixed costs of $61,500 should not be taken into consideration. Afterall, no matter the decision, it would still be incurred and allocated.

Answer 2

Answer: Please refer to Explanation

Step-by-step explanation:

Incremental Cost of Making Product

Variable costs are $2.95 per unit and 50,000 units are to be made. Total Variable Cost is therefore,

= 2.95 * 50,000

= $147,500

Fixed costs associated with the production are$ 67,000 so added tl the variable costs is,

= 147,500 + 67,000

= $214,500

$214,500 is the cost making the product.

Cost of Buying Product

Component can be bought for $3.90 per unit. 50,000 units to be bought gives,

= 50,000 * 3.9

= $195,000

Cost of buying is $195,000

Decision

Company should buy the component as it spends less in buying it than I making it.

Note - Allocated fixed costs were not included in calculation because they will be there regardless of the decision. Hence the term, incremental costs.