Allzine Ltd. currently buys 19,000 subcomponents from an outside supplier at $15 each. The company has excess capacity, which it sublets to another company for $50,000 per year. If the company were to use the idle capacity to produce the subcomponent internally, it would incur variable production costs of $12 per unit, and it would hire a new supervisor for $30,000 per year. Other fixed overhead costs would not change, but the average overhead cost per subcomponent unit would be $2. What is the advantage or disadvantage (in dollars) if Allzine makes the subcomponent instead of continuing to buy outside and subletting the excess capacity?
A) $77,000 advantage
B) $15,000 disadvantage
C) $23,000 advantage
D) $61,000 disadvantage

Question

Quizplus · Accepted Answer

The current cost of buying the subcomponents is 19,000 units * $15 = $285,000. If produced internally, the variable cost is 19,000 units * $12 = $228,000, the supervisor cost is $30,000, and the overhead cost is 19,000 units * $2 = $38,000. The total internal production cost is $228,000 + $30,000 + $38,000 = $296,000. However, producing internally means losing the $50,000 income from subletting, making the effective cost $296,000 + $50,000 = $346,000. The difference between buying and producing internally is $285,000 - $346,000 = -$61,000, indicating a disadvantage. However, the calculation mistake in considering the sublet income as an additional cost when it should be considered as foregone revenue leads to the correct interpretation: The cost of buying is $285,000, and the cost of making is $296,000. The difference is $11,000, not considering the opportunity cost of $50,000 lost from subletting. Therefore, the total disadvantage of making over buying, when including the opportunity cost, is $61,000, not $11,000. This error in my explanation led to an incorrect conclusion. The correct analysis should compare the total costs and savings directly, including all relevant expenses and opportunity costs.