Question

4. Fields Company currently manufactures one of its parts at a cost of $3.25 per unit. This cost is based on a normal production rate of 50,000 units. Variable costs are $2.10 per unit, fixed costs related to making this part are $40,000 per year, and allocated fixed costs are $45,000 per year. Allocated fixed costs are unavoidable whether the company makes or buys the part. Fields is considering buying the part from a supplier for a quoted price of S2.80 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

In making or buy decision company should compare incremental costs in both conditions.

1) Incremental Costs to Make 50000 units

	Relevant Amount per Unit	Relevant fixed Costs	Total Relevant Costs
Variable cost per unit	$2.10		$105,000
Fixed manufacturing costs		$40,000	$40,000
Total incremental cost to make			$145,000

2) Incremental Costs to Buying 50000 units at $2.80 per unit

	Relevant Amount per Unit	Relevant Fixed Costs	Total Relevant Costs
Purchase price per unit	$2.80		$140,000
Total incremental cost to buy			$140,000

Notes . - $45000 allocated fix cost are unavoidable whether the company makes or buys the part, so it is irrelevant

Decision - As total incremental cost under buy option is low by $ 5000 ($145000 - 140000). So company should buy the part from outside supplier.