Question

Santos Company currently manufactures one of its crucial parts at a cost of $4.80 per unit. This cost is based on a normal production rate of 80,000 units per year. Variable costs are $3.30 per unit, fixed costs related to making this part are $80,000 per year, and allocated fixed costs are $40,000 per year. Allocated fixed costs are unavoidable whether the company makes or buys the part. Santos is considering buying the part from a supplier for a quoted price of $3.30 per unit guaranteed for a three-year period.

  

Calculate the total incremental cost of making 80,000 units. (Omit the "$" sign in your response.)

  

Total incremental cost

$

  

Calculate the total incremental cost of buying 80,000 units. (Omit the "$" sign in your response.)

  

Total incremental cost

$

  

Should the company continue to manufacture the part, or should it buy the part from the outside supplier?

Make Buy

Answer 1

Allocated cost (40,000) should not be considered here, since this is unavoidable.

I. cost of making = (Variable cost per unit × Number of units) + Yearly fixed cost

                            = (3.30 × 80,000) + 80,000

                            = 264,000 + 80,000

                            = 344,000 (Answer)

I.cost of buying = Price × Number of units

                           = 3.30 × 80,000

                           = 264,000 (Answer)

Answer: Buy

Since the I. cost of buying is smaller than making, the company should go for buying.