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A company currently makes a component used in production. The per unit costs incurred to make the component include: Direct materials: $5; Direct labor: $2; Overhead: $4; Total cost: $11. Twenty-five percent of the overhead costs are considered incremental. The company can purchase the component from another source for $10. The company should do which of the following?
A. The company should not make the components because incremental costs are $2 less than the purchase price
B. The company should make the components because incremental costs are $2 less than the purchase price
C. None of above

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Answer:

The correct answer is B.

Explanation:

Giving the following information:

Direct materials: $5

Direct labor: $2

Avoidable Overhead: $1

Total cost: $8.

The company can purchase the component from another source for $10.

The unitary cost of making the product is $8. $3 of the overhead is unavoidable, therefore it is irrelevant to the decision making process.

The difference between making and buying is $2, being cheaper for making in-house.

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