Question

Make-or-Buy Decision

Fremont Computer Company has been purchasing carrying cases for its portable computers at a purchase price of $56 per unit. The company, which is currently operating below full capacity, charges factory overhead to production at the rate of 40% of direct labor cost. The unit costs to produce comparable carrying cases are expected to be as follows:

Direct materials	$29
Direct labor	16
Factory overhead (40% of direct labor)	6.4
Total cost per unit	$51.4

If Fremont Computer Company manufactures the carrying cases, fixed factory overhead costs will not increase and variable factory overhead costs associated with the cases are expected to be 14% of the direct labor costs.

a. Prepare a differential analysis dated September 30 to determine whether the company should make (Alternative 1) or buy (Alternative 2) the carrying case. If required, round your answers to two decimal places. If an amount is zero, enter "0". Use a minus sign to indicate a loss.

Differential Analysis
Make Carrying Case (Alt. 1) or Buy Carrying Case (Alt. 2)
September 30
	Make Carrying Case (Alternative 1)	Buy Carrying Case (Alternative 2)	Differential Effect on Income (Alternative 2)
Sales price	$	$	$
Unit costs:
Purchase price
Direct materials
Direct labor
Variable factory overhead
Fixed factory overhead
Income (Loss)	$	$	$

b. Assuming there were no better alternative uses for the spare capacity, it would be advisable  to manufacture the carrying cases. Fixed factory overhead is irrelevant  to this decision.

Answer 1

Answer a)

Differential Analysis

September 30

(Amount in $)

	Make Carrying Case	Buy Carrying Case	Differential Effect on Income
(Alternative 1)	(Alternative 2)	(Alternative 2)
Sales Price			0
Unit Costs:
Purchase Price	-	(56.00)	56.00
Direct Materials	(29.00)	-	(29.00)
Direct Labor	(16.00)	-	(16.00)
Variable Factory Overheads ($ 16.00 X 14%)	(2.24)	-	(2.24)
Fixed factory Overheads	-	-
Income (loss)			8.76

Note: Fixed factory overheads are sunk cost as there are allocated to carrying cases and not incurred for it. Moreover, of the company decides to manufacture the carrying cases, there will not be any increase in fixed overheads and thus no part of it has been included in cost of making the carrying case.

Answer b)

If there are no alternative uses for the spare capacity, it is better to make the carrying case as it will result in increase in income of $ 8.76 per carrying case.