Sardi Incorporated is considering whether to continue to make a component or to buy it from an outside supplier. The company uses 14,200 of the components each year. The unit product cost of the component according to the company's cost accounting system is given as follows: Assume that direct labor is a variable cost. Of the fixed manufacturing overhead, 30% is avoidable if the component were bought from the outside supplier. In addition, making the component uses 1 minutes on the machine that is the company's current constraint. If the component were bought, time would be freed up for use on another product that requires 2 minutes on this machine and that has a contribution margin of $6.40 per unit.When deciding whether to make or buy the component, what cost of making the component should be compared to the price of buying the component? (Round your intermediate calculations to 2 decimal places.)
A) $27.80 per unit
B) $24.00 per unit
C) $21.24 per unit
D) $24.44 per unit

Question

Sardi Incorporated is considering whether to continue to make a component or to buy it from an outside supplier. The company uses 14,200 of the components each year. The unit product cost of the component according to the company's cost accounting system is given as follows:  Assume that direct labor is a variable cost. Of the fixed manufacturing overhead, 30% is avoidable if the component were bought from the outside supplier. In addition, making the component uses 1 minutes on the machine that is the company's current constraint. If the component were bought, time would be freed up for use on another product that requires 2 minutes on this machine and that has a contribution margin of $6.40 per unit.When deciding whether to make or buy the component, what cost of making the component should be compared to the price of buying the component? (Round your intermediate calculations to 2 decimal places.)
A) $27.80 per unit 
B) $24.00 per unit 
C) $21.24 per unit 
D) $24.44 per unit

Quizplus · Accepted Answer

The relevant cost of making the component that should be compared to the price of buying the component is the incremental cost. The incremental cost is the cost that will be avoided if the component is bought from the outside supplier instead of being made in-house.

Incremental cost = Avoidable fixed cost + Variable cost
Avoidable fixed cost = 30% x fixed overhead cost = 30% x $24,000 = $7,200
Variable cost per unit = Direct materials + Direct labor + Variable overhead = $12.00 + $4.00 + $2.80 = $18.80

Incremental cost = $7,200/14,200 + $18.80 = $0.51 + $18.80 = $19.31

If the component is bought, an additional 1 minute on the machine is freed up. The opportunity cost of using this 1 minute to produce another product is the contribution margin of that product.

Contribution margin per minute on machine = $6.40/2 = $3.20
Opportunity cost of 1 minute on machine = $3.20 x 1 = $3.20

Therefore, the maximum price that the company should be willing to pay to buy the component is:

Maximum price = Incremental cost + Opportunity cost
Maximum price = $19.31 + $3.20 = $22.51

Since the price of buying the component is $21.00, it is more cost-effective to buy the component from the outside supplier rather than making it in-house. The correct answer is D.

Sardi Incorporated Is Considering Whether to Continue to Make a Component