Question

Gilberto Company currently manufactures 50,000 units per year of one of its crucial parts. Variable costs are $2.50 per unit, fixed costs related to making this part are $50,000 per year, and allocated fixed costs are $50,000 per year. Allocated fixed costs are unavoidable whether the company makes or buys the part. Gilberto is considering buying the part from a supplier for a quoted price of $3.70 per unit guaranteed for a three-year period.Required:1. Calculate the total incremental cost of making 50,000 units.2. Calculate the total incremental cost of buying 50,000 units.

Answer 1

a. Incremental cost of making the part $

Variable cost (50,000 units x $2.50) = 125,000

Attributable fixed cost = 50,000

Incremental cost 175,000

b. Incremental cost of buying the part from outside

= 50,000 units x $3.70

= $185,000

Explanation: The incremental cost of making the part is the total relevant cost of production, which involves variable cost and attributable fixed cost.

The incremental cost of buying the component refers to cost of buying the part from outside.