Answer:
The Alternative to Make the product is better.
Explanation:
Requirement 1:
Calculate relevant costs for each alternative as shown below:
Detai Make Buy
Relevant Costs:
Purchase Cost $25.00
Direct Material $12.00
Direct Labour $8.25
Variable overhead $4.50
Total $24.75 $25.00
Differential cost to make per unit
($2435-$25 .00)
($0.25)
If production of Component 1(2 stopped, none of fixed costs would be eliminated. None of the fixed cost is relevant.
If Z purchase the component from outside supplier, then Z’s operating income will be decreased by $2,500 (10,000 units x $0.2sper unit). As the differential cost to make perunit is $0.25 less than to buy alternative. Hence, operating income will be decreased.
Calculate total relevant cost if 75% of fixed cost is eliminated
Avoidable fixed cost = ($2.00 X 75%) = $1.50
Details Make Buy
Relevant Costs:
Purchase Cost $25.00
Direct Material $12.00
Direct Labour $8.25
Variable overhead $4.50
Fixed overhead (Avoidable 75%j $2 x 75%)
$1.50
Total Relevant cost $26.25 $25.00
Differential cost to make per unit
($26.25-$25.00)
$1 25
.
In this situation, relevant cost $1.25 more to make the component rather than to buy.
If Z buy the component from outside supplier, Z’s operating income will be increased by
$12,500 ($1.25 X 10,000).
Requirement 2:
Relevant fixed cost per unit must decrease by $1.25 from $1.50 to $0.25 to make Z
indifferent.
Details Make Buy
Relevant Costs:
Purchase Cost $25.00
Direct Material $12.00
Direct Labour $815
Variable overhead $4.50
Fixed overhead (Avoidable) $0.25
Total Relevant cost $25.00 $25.00
Differential cost to make per unit
(S25.00-$25.00)
Hence, at this point, total cost to make the component and to buy the component would be the same.
