Question

Wilma Company must decide whether to make or buy some of its components. The costs of producing 60,000 switches for its generators are as follows.

Direct materials $29,000
Variable overhead $44,000
Direct labor $25,000
Fixed overhead $76,000
Instead of making the switches at an average cost of $2.90 ($174,000 ÷ 60,000), the company has an opportunity to buy the switches at $2.65 per unit. If the company purchases the switches, all the variable costs and one-fourth of the fixed costs will be eliminated.

Prepare an incremental analysis showing whether the company should make or buy the switches.

Answer 1

Answer:

Wilma Company should produce internally as this will savings of $42,000.

Explanation:

For a make or buy decision the relevant cash flows include  

1. the differential variable of the two options  

2. savings from avoidable fixed costs associated with internal production

Incremental analysis                                                    $

External cost of purchase($2.65 × 60,000)             159000

Variable cost - (29,000 + 44,000 + 25,000)        =    98000

Extra variable cost of external purchase                    (61000 )

Savings in Avoidable fixed cost  (1/4× 76,000)         19,000

Net  extra cost of external purchase                       (42000 )

Wilma Company should produce internally as this will savings of $42,000.