Question

Gelb Company currently manufactures 40,000 units per year of a key component for its manufacturing process. Variable costs are \(1.95 per unit, fixed costs related to making this component are \)65,000 per year, and allocated fixed costs are \(58,500 per year. The allocated fixed costs are unavoidable whether the company makes or buys this component. The company is considering buying this component from a supplier for \)3.50 per unit. Should it continue to manufacture the component, or should it buy this component from the outside supplier? Support your decision with analysis of the data provided

Short answer

The incremental cost of buying the component from the supplier is $140,000.

Step-by-step solution

Definition of fixed cost

The fixed cost is the cost that remainsfixed during the whole manufacturing process.

Calculation of incremental cost

Incremental Cost to Make
	Relevant Amount per Unit	Relevant Fixed Cost	Total Relevant Cost
Variable Costs	$1.95		$78,000
Fixed Costs related to making components		$58,000	$58,000
Total Incremental Cost to Make			$136,000

Incremental Cost to Buy
	Relevant Amount per Unit	Relevant Fixed Cost	Total Relevant Cost
Variable Costs	$3.50		$140,000
Fixed Costs related to making components
Total Incremental Cost to Make			$140,000

The company should continue to manufacture the component because purchasing components from suppliers will incur more costsfor the company.