Question

is a manufacturer of wireless keyboards. The annual costs to manufacture the 100,000 keyboards needed each year are as follows: Total Cost Direct materials $1,200,000 Direct labor 500,000 Variable manufacturing overhead 350,000 Fixed manufacturing overhead 500,000 Total $2,550,000 Another company has offered to provide Blue Devil with all of its annual production needs for $25 per keyboard. If Blue Devil accepts this offer, 40% of the fixed manufacturing overhead above could be totally eliminated. Also, Blue Devil would be able to rent out the processing machines and equipment’s to generate $100,000 of income annually. Assume that direct labor is a variable cost. Required: Based on this information, would Blue Devil be financially better off to continue making the keyboards or to buy them from another company

Answer 1

Answer:-

Incremental Analysis:- Incremental Analysis is a tool used in the make or buy decision by manufacturing concern. The present costs are compared with the costs that will be incurred if the product is bought from another company.

Calculation of per keyboard marginal cost of production if we make the product

Sr.No	Particulars	Amount (in $)
1)	Direct Materials	1200000
2)	Direct Labour	500000
3)	Variable Manufacturing Overheads	350000
4)	Fixed Manufacturing Overheads	500000
	Total Cost	2550000
	No. of units Produced	100000
	Cost per unit of Keyboard	25.5

So if the keyboard is produced in the company itself total cost per unit of production shall be $ 25.5

(B) Calculation of cost per keyboard if the keyboard is purchased from another company.

1) Direct material cost will be totally eliminated if the keyboard is purchased from another company.

2) As specified in the question, Direct Labour is a variable cost and varies with the production level. Since the entire product will be purchased from another company hence no labour cost will be incurred.

3) Similarly variable overhead costs will be totally eliminated.

4) Given that Fixed Variable costs will be reduced by 40% if the product is bought from outside.

Hence in the given case fixed overhead cost shall be equal to 500000 - 40% = $ 300000.

So total costs which will be incurred shall be $ 300000.

On the other hand, Blue Devil would be able to rent out the processing machines and equipment’s to generate $100,000 of income annually. So the total cost will reduce to that extend in this scenario.

So total costs if the product is purchased from another company will be $ 300000 - $100000 = $200000.

So per unit costs that will be incurred even if the product is purchased from another company shall be equal to $200000/ 100000 units = $ 2/ keyboard

So per unit cost of purchasing keyboard from other company shall be = Purchase price + cost incurred even if product purchased from other company

= $25 + $ 2 = $27 / keyboard.

Since we can see from above that, purchasing the keyboard from another company shall cost Blue Devil $27 / unit while making the keyboard by themselves would cost $ 25.5/ unit. Hence it would be financially better off to continue making the keyboards rather then to buy them from another company.

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