Question:
Currently, GreenCut Lawnmowers produces all of the transmissions used in its riding lawnmowers in-house. Its annual costs for producing these 45,000 transmissions are detailed below:
Direct material 765,000
Direct labor 270,000
variable overhead 240,000
Fixed manufacturing overhead <u>150,000</u>
Total manufacturing cost <u>1,425,000</u>
Instead of making its own transmissions, GreenCut is considering buying them from a supplier at a price of $30 each. Based on incremental analysis, GreenCut should
Answer:
Green Cut should produce/make the transmission internally because doing so would it $15,000
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( $30× 45,000) 1,350,000
Variable cost of making
(765,000 + 270,000 + 250,000) <u>(1,185,000
)</u>
Extra variable cost of external purchase 165,000
Savings in Avoidable fixed cost <u> (150,000</u>)
Net extra cost of external purchase cost 15,000
Note that the fixed manufacturing cost are unavoidable cost i.e which means they would be incurred either way.
Decision
Green Cut should produce/make the transmission internally because doing so would it $15,000
