Sparrow Co. is currently operating at 80% of capacity and is currently purchasing a part used in its manufacturing operations for $8.00 a unit. The unit cost for Sparrow Co. to make the part is $9.00, which includes $0.60 of fixed costs. If 4,000 units of the part are normally purchased each year but could be manufactured using unused capacity, what would be the amount of differential cost increase or decrease for making the part rather than purchasing it?
A) $12,000 decrease
B) $4,000 increase
C) $20,000 decrease
D) $1,600 increase

Question

Quizplus · Accepted Answer

The differential cost to make the part instead of purchasing it is calculated by comparing the total costs of both options. The cost to purchase the part is $8.00 per unit, and the variable cost to make the part (excluding the fixed cost of $0.60) is $8.40 ($9.00 - $0.60). For 4,000 units, the additional cost to make the part is ($8.40 - $8.00) * 4,000 = $1,600 increase. Fixed costs are not considered in the differential cost since they do not change with the decision to make or buy the part.