Question

Paxton Company can produce a component of its product that incurs the following costs per unit: direct materials, $9.90; direct labor, $13.90, variable overhead $2.90 and fixed overhead, $7.90. An outside supplier has offered to sell the product to Paxton for $34.60. Compute the net incremental cost or savings of buying the component.
a.$2.90 cost per unit.
b. $7.90 savings per unit.
c. $0 cost or savings per unit.
d. $7.90 cost per unit.
e. $2.90 savings per unit.

Answer 1

Answer:

D) $7.90 cost per unit

Explanation:

This can be calculated by identifying the relevant costs that will be affected by the transaction. $7.9 is a fixed overhead and will be paid regardless of producing the component in house or purchasing from an external source thus this needs to be omitted from the calculation. So the new cost of producing in house is,

Relevant Cost = 9.9 + 13.90 + 2.9 = $26.7

Thus the incremental cost of this transaction would be

Incremental Cost = 34.60 - 26.7 = $7.90

It is not advisable to purchase this as if they do they will have to pay $34.60 for purchase and would also have to absorb $7.90 of fixed overheads bringing the total cost incurred to 34.60 + 7.90 =$42.5

Hope that helps.