Pett Company produces a part that is used in the manufacture of one of its products. The costs associated with the production of 5,000 units of this part are as follows:
Of the fixed factory overhead costs, $15,000 is avoidable.
-Assume that Pett can buy 5,000 units of the part from another producer for $21 each. The current facilities could be used to make 5,000 units of a product that has a contribution margin of $5 per unit. Fixed factory overhead costs to produce this new product would be exactly the same as for the currently produced part. Pett should
A) continue to make the part and earn an extra $10,000 in profit.
B) buy the part and produce the new product and earn an extra $1 per unit contribution to profit.
C) continue to make the part and earn an extra $2 per unit contribution to profit.
D) buy the part and produce the new product and earn an extra $5 per unit contribution to profit.

Question

Pett Company produces a part that is used in the manufacture of one of its products. The costs associated with the production of 5,000 units of this part are as follows:
  Of the fixed factory overhead costs, $15,000 is avoidable.
-Assume that Pett can buy 5,000 units of the part from another producer for $21 each. The current facilities could be used to make 5,000 units of a product that has a contribution margin of $5 per unit. Fixed factory overhead costs to produce this new product would be exactly the same as for the currently produced part. Pett should
A) continue to make the part and earn an extra $10,000 in profit. 
B) buy the part and produce the new product and earn an extra $1 per unit contribution to profit. 
C) continue to make the part and earn an extra $2 per unit contribution to profit. 
D) buy the part and produce the new product and earn an extra $5 per unit contribution to profit.

Quizplus · Accepted Answer

The relevant cost of producing 5,000 units of the part is $135,000 ($60,000 variable costs + $75,000 fixed costs - $15,000 avoidable fixed costs). If Pett buys the part for $21 each, the cost would be $105,000 (5,000 units x $21 each). Therefore, buying the part would save $30,000 ($135,000 - $105,000).

If Pett produces the new product, it would earn an extra $25,000 in contribution margin ($5 contribution margin x 5,000 units). The fixed factory overhead costs to produce the new product would be the same as for the currently produced part, so Pett would not incur additional fixed costs.

Therefore, the best choice for Pett is to buy the part and produce the new product, which would earn an extra $25,000 in contribution margin and save $30,000 in relevant costs, for a total increase in profit of $55,000.

Pett Company Produces a Part That Is Used in the Manufacture