Question

Frederick Co. is thinking about having one of its products manufactured by an outside supplier.

Currently, the cost of manufacturing 5,000 units is:

Direct material	$	62,000
Direct labor		47,000
Variable factory overhead		38,000
Factory overhead		52,000

If Frederick can buy 5,000 units from an outside supplier for $130,000, it should:

• Make the product because the cost of direct material plus direct labor of manufacturing is less than $130,000.

• Make the product because factory overhead is a sunk cost.

• Buy the product because the total incremental costs of manufacturing are greater than $130,000.

• Buy the product because total fixed and variable manufacturing costs are greater than $130,000.

• Make the product because current factory overhead is less than $130,000.

Answer 1

Variable cost of making 5,000 units = Direct material + Direct labor + Variable factory overhead

= 62,000 + 47,000 + 38,000

= $147,000

Cost of buying 5,000 units from outside supplies = $130,000

Since, cost of buying is less than variable cost of making, thus it is economical to buy from the outside suppliers rather than to make units.

Fixed factory overhead will not affect the decision since it will be incurred whether to make the units or buy units from the outside suppliers.

Only incremental cost i.e. variable cost of making will be considered.

Third option is the correct option.