Question

A company manufactures various-sized plastic bottles for its medicinal product. The manufacturing cost for small bottles is $55 per unit (100 bottles), including fixed costs of $12 per unit. A proposal is offered to purchase small bottles from an outside source for $36 per unit, plus $3 per unit for freight.
Required:
Prepare a differential analysis dated January 25 to determine whether the company should make (Alternative 1) or buy (Alternative 2) the bottles, assuming fixed costs are unaffected by the decision.

Answer 1

Answer:

Differential Analysis on January 25:

                                        Make                Buy           Difference

                                  Alternative 1   Alternative 2

Avoidable costs                 $43               $39                 $4

per unit of (100 bottles)

Explanation:

a) Data and Calculations:

Variable manufacturing cost per unit = $43 ($55 - $12)

Fixed manufacturing cost per unit =         12

Total manufacturing cost per unit =      $55

Outside supplier's offered price per unit = $36

Freight per unit for outside supply =               3

Total outside supply cost per unit =            $39

b) There is an additional avoidable cost of $4 per unit to make the bottles.  From a financial point of view, it will be cost-effective to buy the bottles from the outside supplier.  If the company finds an alternative use of the production facilities, the cost difference will increase.