Hadley, Inc. makes a line of bathroom accessories. Because of a decline in sales

Question

Hadley, Inc. makes a line of bathroom accessories. Because of a decline in sales, the company has 10,000 machine hours of idle capacity available each year. This idle capacity could be used by the company to make, rather than buy, one of the components used in its production process. Hadley needs 5,000 units of this component each year. At present, the component is being purchased from an outside supplier at $7.50 per unit. Variable production cost for the component would be $4.10 per unit, and additional supervisory costs would be $18,000 per year. Already existing fixed costs, which would be allocated to this part, amount to $300,000 per year.

What would the annual cost of additional supervision have to be in order for Hadley to be economically indifferent to making or buying the component? (Assume all other conditions stay the same.)

Explanation / Answer

Incremental cost per unit if the part is made internally = Variable production cost per Unit + additional supervisory costs/No of Unit Produced

Incremental cost per unit if the part is made internally = 4.10 + 18000/5000

Incremental cost per unit if the part is made internally = $ 7.70

Decision : Hadley Should buy the component

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