Question

Sage company is operating at 90% of capacity and is currently purchasing a part used in its manufacturing operations for $15 per unit. the unit cost for the business to make the part is $20, including fixed costs, and $11, not including fixed costs. if 30,000 units of the part are normally purchased during the year but could be manufactured using unused capacity, what would be the amount of differential cost increase or decrease from making the part rather than purchasing it?

Answer 1

In order to find the differential cost we shall ignore fixed cost as, these costs are going to be incurred irrespective of whether the product is going to be purchased or manufactured.

Cost of Manufacture Cost of Purchase

Per Unit 11 15

30000 Units $330000 $450000

Thus as can be observed the differential cost of Purchasing the product is $120000. The company spend $120000 if the purchases the product from the third party, hence its advisable if the company manufactures it in-house.