Question

Santos Company currently manufactures one of its crucial parts at a cost of $4.85 per unit. This cost is based on a normal production rate of 60,000 units per year. Variable costs are $3.10 per unit, fixed costs related to making this part are $60,000 per year, and allocated fixed costs are $45,000 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 $3.50 per unit guaranteed for a three-year period Calculate the total incremental cost of making 60,000 units. (Omit the "$" sign in your response.) Total incremental cost Calculate the total incremental cost of buying 60,000 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

Total incremental Cost of making 60,000 units = (60,000 * $3.10) + $60,000 = $246,000

Total incremental Cost of buying 60,000 units = 60,000 * $3.50 = $210,000

Allocated fixed cost is not considered because it is unavoidable cost whether the company manufactures of buys the product.

Hence, from the above, we can conclude that the company should Buy the parts from the outside supplier as the incremental cost of buying the part is less than the incremental cost of manufacturing the product.