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Exercise 7-16 (15 minutes)
Relevant Costs
Item
Make
Buy
Direct materials (60,000 @ $4.00) .............
$240,000
Direct labor (60,000 @ $2.75) ...................
165,000
Variable manufacturing overhead
(60,000 @ $0.50) ...................................
30,000
Fixed manufacturing overhead, traceable
(1/3 of $180,000) ...................................
60,000
Cost of purchasing from outside supplier
(60,000 @ $10) .....................................
$600,000
Total cost .................................................
$495,000
$600,000
The two-thirds of the traceable fixed manufacturing overhead costs that
cannot be eliminated, and all of the common fixed manufacturing overhead
costs, are irrelevant.
The company would save $105,000 per year by continuing to make the
parts itself. In other words, profits would decline by $105,000 per year if
the parts were purchased from the outside supplier.
