Cherry Company makes telephones.Currently, Cherry makes all the components of the telephones in-house.An outside company has offered to supply one component, part number X76, for $15 each.Cherry uses 15,000 of these components per year.Costs of X76 are as follows:
Assume that all of the fixed overhead is allocated and cannot be avoided.Should Cherry purchase the part from the outside supplier?

Question

Cherry Company makes telephones.Currently, Cherry makes all the components of the telephones in-house.An outside company has offered to supply one component, part number X76, for $15 each.Cherry uses 15,000 of these components per year.Costs of X76 are as follows: 
 Assume that all of the fixed overhead is allocated and cannot be avoided.Should Cherry purchase the part from the outside supplier?

Quizplus · Accepted Answer

Relevant cost per unit = Direct materials + Direct labor + Variable overhead Relevant cost per unit = $2 + $2 + $3 = $7
Decrease in income if purchased = (Cost of making - Cost of buying) × Number of units required Decrease in income if purchased = ($7 - $15) × 15,000 units = $120,000
Income will decrease by $120,000 if the part is purchased.

Cherry Company Makes Telephones