Sparrow Co.is currently operating at 80% of capacity and is currently purchasing a part used in its manufacturing operations for $8.00 a unit.The unit cost for Sparrow Co.to make the part is $9.00,which includes $0.60 of fixed costs.If 4,000 units of the part are normally purchased each year but could be manufactured using unused capacity,what would be the amount of differential cost increase or decrease for making the part rather than purchasing it?
A) $12,000 cost decrease
B) $4,000 cost increase
C) $20,000 cost decrease
D) $1,600 cost increase

Question

Quizplus · Accepted Answer

The differential cost to make the part instead of purchasing it is calculated by comparing the total cost of making the parts to the total cost of purchasing them. The cost to make the part is $9.00 per unit, but this includes $0.60 of fixed costs that will not change whether the parts are made or bought. Therefore, the variable cost to make the part is $9.00 - $0.60 = $8.40 per unit. For 4,000 units, the total variable cost to make the parts is 4,000 units * $8.40 = $33,600. The cost to purchase the parts is $8.00 per unit, so for 4,000 units, the total cost to purchase is 4,000 units * $8.00 = $32,000. The differential cost increase for making the part rather than purchasing it is $33,600 - $32,000 = $1,600.