Question

Question Gilberto Company currently manufactures 65,000 units per year of one of its crucial parts. Variable costs are $1.95 per unit, fixed costs related to making this part are $75,000 per year, and allocated fixed costs are $62,000 per year. Allocated fixed costs are unavoidable whether the company makes or buys the part. Gilberto is considering buying the part from a supplier for a quoted price of $3.25 per unit guaranteed for a three-year period. Should the company continue to manufacture the part, or should it buy the part from the outside supplier? Support your answer with analyses.

Answer 1

Step 1: Definition of incremental cost

 

The incremental cost is the cost that is increased by choosing the various course of action.

 

Step 2: Calculation of incremental cost to make and buy the parts.

 

First of all, the total incremental cost of making is calculated.

 

Incremental Costs to Make
	Relevant Amount per Unit	Relevant Fixed Cost	Total Relevant Cost
Variable Cost Per Unit	$1.95		$126,750
Fixed Manufacturing Costs		$75,000	$75,000
Total Incremental Cost to Make			$201,750

 

Now, the total incremental cost to buy is calculated.

 

Incremental Costs to Make
	Relevant Amount per Unit	Relevant Fixed Cost	Total Relevant Cost
Purchase Price Per Unit	$1.95		$211,250
Total Incremental Cost to Buy			$211,250

 

Hence, the cost to buy the crucial parts is $211,250.

The company should continue to make the parts.