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12 August, 08:10

Wilma Company must decide whether to make or buy some of its components. The costs of producing 60,000 switches for its generators are as follows.

Direct materials $29,000

Variable overhead $44,000

Direct labor $25,000

Fixed overhead $76,000

Instead of making the switches at an average cost of $2.90 ($174,000 : 60,000), the company has an opportunity to buy the switches at $2.65 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 make or buy the switches.

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  1. 12 August, 08:20
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    Wilma Company should produce internally as this will savings of $42,000.

    Explanation:

    For a make or buy decision the relevant cash flows include

    1. the differential variable of the two options

    2. savings from avoidable fixed costs associated with internal production

    Incremental analysis $

    External cost of purchase ($2.65 * 60,000) 159000

    Variable cost - (29,000 + 44,000 + 25,000) = 98000

    Extra variable cost of external purchase (61000)

    Savings in Avoidable fixed cost (1/4 * 76,000) 19,000

    Net extra cost of external purchase (42000)

    Wilma Company should produce internally as this will savings of $42,000.
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