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Gelb Company currently manufactures 54,000 units per year of a key component for its manufacturing process. Variable costs are $4.05 per unit, fixed costs related to making this component are $85,000 per year, and allocated fixed costs are $71,500 per year. The allocated fixed costs are unavoidable whether the company makes or buys this component. The company is considering buying this component from a supplier for $3.70 per unit. Calculate the total incremental cost of making 54,000 units and buying 54,000 units. Should it continue to manufacture the component, or should it buy this component from the outside supplier

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Answer and Explanation:

a. The total incremental cost of making 54,000 units is shown below

Incremental Costs to Make

Particulars             Amount Per Unit  Fixed Costs Total Relevant Costs

Variable Cost Per Unit $4.05                         $218,700 (54,000 units × $4.05)

Fixed Manufacturing Costs           $85,000         $85,000

Total Incremental Costs to Make                    $303,700

b The total incremental cost of buying 54,000 units is given below

Particulars             Amount Per Unit  Fixed Costs Total Relevant Costs

Variable Cost Per Unit $3.70                                 $199,800 (54,000 units × $3.70)

Total Incremental Costs to Buy                    $199,800

c.  As we can see that the company should buy the component from outside supplier as it reflects the a lower total incremental cost of $199,800 as compared to the making cost i.e $303,700

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