Chapter 7, Problem 7.8E

Prepare incremental analysis concerning make-or-buy decision.

(LO 3), E

Innova uses 1,000 units of the component IMC2 every month to manufacture one of its products. The unit costs incurred to manufacture the component are as follows.

Direct materials	$ 65.00
Direct labor	45.00
Overhead	126.50
Total	$236.50

Overhead costs include variable material handling costs of $6.50, which arc applied to products on the basis of direct material costs. The remainder of the overhead costs are applied on the basis of direct labor dollars and consist of 60% variable costs and 40% fixed costs.

A vendor has offered to supply the IMC2 component at a price of $200 per unit.

Instructions

(a) Should Innova purchase the component from the outside vendor if Innova’s capacity remains idle?

(b) Should Innova purchase the component from the outside vendor if it can use its facilities to manufacture another product? What information will Innova need to make an accurate decision? Show your calculations.

(c) What are the qualitative factors that Innova will have to consider when making this decision?

(CGA adapted)