Multiple Choice QuestionA company currently makes a component used in production. The per unit costs incurred to make the component include: Direct materials: $5; Direct labor: $2; Overhead: $4; Total cost: $11. Twenty-five percent of the overhead costs are considered incremental. The company can purchase the component from another source for $10. The company should do which of the following?Multiple choice question.The company can be indifferent because incremental costs are $10 and the purchase price is $10.The company should buy the components to save $1 per unit.The company should make the components because incremental costs are $2 less than the purchase price.The company should buy the components to save $2 per unit.
Question
Multiple Choice QuestionA company currently makes a component used in production. The per unit costs incurred to make the component include: Direct materials: 2; Overhead: 11. Twenty-five percent of the overhead costs are considered incremental. The company can purchase the component from another source for 10 and the purchase price is 1 per unit.The company should make the components because incremental costs are 2 per unit.
Solution
The company should make the components because incremental costs are $2 less than the purchase price.
Here's the step-by-step reasoning:
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First, identify the incremental costs of making the component. Incremental costs are the costs that will be eliminated if the component is not made. In this case, the incremental costs are the direct materials, direct labor, and 25% of the overhead costs. So, the incremental cost per unit is 2 (direct labor) + 7 + 8.
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Compare the incremental cost of making the component with the cost of purchasing the component. The cost of purchasing the component is $10 per unit.
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Since the incremental cost of making the component (10), the company should continue to make the component. This decision will save the company $2 per unit.
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