E12-5 Use incremental analysis for make-or-buy decision Pottery Ranch Inc. has b

Question

E12-5 Use incremental analysis for make-or-buy decision      Pottery Ranch Inc. has been manufacturing its own finials for its curtain rods. The company is currently operating at 100% of capacity, and variable manufacturing is charged to production at the rate of 70% of direct labor cost. The direct materials and the direct labor cost per unit to make a pair of finials are $4 and $5, respectively. Normal production is 30,000 curtain rods per year.      A supplier offers to make a pair of finials at a price of $12.95 per unit. If Pottery Ranch accepts the supplier's offer, all variable manufacturing costs will be eliminated, but the $45,000 of fixed manufacturing overhead currently being charged to the finials will have to be absorbed by other products. Instructions (a) Prepare the incremental analysis for the decision to make or buy the finials. (b) Should Pottery Ranch buy the finials? (c ) Would your answer be different in (b) if the productive capacity released by not making the finials could be used to produce income of $20,000? NOTE: Enter a number in cells requesting a value; enter either a number or a formula in cells with a "?" . (a) Prepare the incremental analysis for the decision to make or buy the finials Net income Increase Make Buy Direct materials Direct labor Variable overhead cost Fixed manufacturinqc Purchase price Total annual costs (b) Should Pottery Ranch buy the finials? (c) Would your answer be different in (b) if the productive capacity rele ased by not makindq the finials could be used to produce income of $20,000 Net income Increase Make Buy Total annual cost Value Value Total cost

Explanation / Answer

a) make buy Net Income increase (decrease) Direct Mat 120000 120000 DL 150000 150000 Variable O/H cost 105000 0 F Manuf cost Purchase price 388500 388500 Total annual costs 375000 388500 -13500 b) Pottery should make the finials as the company will incure loss on buying the equipment. c) If the capacity so released makes a income of $20000, then Make Buy Net Income Inc (Dec) Total annual costs 375000 388500 -13500 Opportunity cost -20000 20000 Total cost 375000 368500 6500 In this case, the `company has to buy the equipment as it makes a income of $6500.

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