Gelb Company currently manufactures 53,500 units per year of a key component for its manufacturing process. Variable costs are $2.95 per unit, fixed costs related to making this component are $67,000 per year, and allocated fixed costs are $64,500 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. Calculate the total incremental cost of making 53,500 units and buying 53,500 units. Should it continue to manufacture the component, or should it buy this component from the outside supplier

Answer and Explanation:

The computation of the total incremental cost is shown below;

For making 53,500 units

ParticularsRelevant     Relevant            Total

                       Per Unit    Fixed Costs        Relevant Costs

Variable Cost

Per Unit           $2.95                          $157,825

                                                                    (53,500 units × $2.95)

Fixed

Manufacturing

Costs                        $67,000           $67,000

Total Incremental Costs to Make  $224,825

For making 53,500 units

ParticularsRelevant     Relevant            Total

                       Per Unit    Fixed Costs        Relevant Costs

Purchase

Price

Per Unit        $3.50                                  $187,250

                                                                    (53,500 units × $3.50)

Total Incremental Cost to Buy  $187,250

The company should buy the component from the outside supplier as it saves the cost for ($224,825 - $187,250) = $37,575 plus the buying cost is less than the making cost

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