Wilma Company must decide whether to make or buy some of its components. The cos

Question

Wilma Company must decide whether to make or buy some of its components. The costs of producing 60, 500 switches for its generators are as follows. Instead of making the switches at an average cost of $2.96 ($179,080 60,500), the company has an opportunity to buy the switches at $2.70 per unit. If the company purchases the switches, all the variable costs and one-fourth of the fixed costs will be eliminated. Prepare an incremental analysis showing whether the company should buy the switches. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).) Wilma Company will incur $ of additional costs if it the switches.

Explanation / Answer

The decision of make or buy is based on the comparison of relevant costs of manufacturing and the cost of buying and choosing the lower one. In the above question, the relevant fixed costs are 1/4th of the total fixed costs as this portion is to be incurred only if production is done. Rent 3/4th of the fixed costs is non relevant as these are sunk costs and are to be incurred even if production is not done.

Relevant fixed costs = 1 /4 of $83,600 = $20,900

Purchase cost = Quantity x Price = 60,500 x $2.70 = $163,350

Incremental analysis

So, Wilma company will incur $46,970 of additional costs if it buys the switches.

Particulars Make Buy Net Income Increase(decrease) Direct materials 29600 0 -29600 Direct Labor 21480 0 -21480 Variable manufacturing costs 44400 0 -44400 Fixed manufacturing costs 20900 0 -20900 Purchase price 0 163350 163350 Total Costs 116380 163350 46970

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