Question

Santos Company currently manufactures one of its crucial parts at a cost of $5.20 per unit. This cost is based on a normal production rate of 70,000 units per year. Variable costs are $3.70 per unit, fixed costs related to making this part are $70,000 per year, and allocated fixed costs are $35,000 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 $2.90 per unit guaranteed for a three-year period.

  

Calculate the total incremental cost of making 70,000 units. (Omit the "$" sign in your response.)

  

Total incremental cost

$

  

Calculate the total incremental cost of buying 70,000 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?

Buy Make

Answer 1

Solution:
1st	Total incremental cost                   $	329000
Working Notes:
		Relevant Amount per Unit	Relevant fixed Costs	Total Relevant Costs
	Variable cost per unit	3.7		259000
	[70,000 x 3.70 ]
	Fixed manufacturing costs		70000	70000
	Total incremental cost to make			329000
2nd
	Total incremental cost                   $	203000
Working Notes:
		Relevant Amount per Unit	Relevant Fixed Costs	Total Relevant Costs
	Purchase price per unit	2.9		203000
	[70,000 x 2.90 ]
	Total incremental cost to buy			203000
3rd	Buy
Notes:	Since, variable cost per unit is $3.70 which is higher than buying cost per $2.90, hence it is beneficial to Buying than to make.
	And
	Overall incremental cost of making is also higher $329,000 in comparison to Buying incremental cost $203000
Notes:	Allocated fixed cost are not relevant cost as it will be same whether we buy or make
Please feel free to ask if anything about above solution in comment section of the question.