Question

Instead of making canopies for their trailers Ajay Metal Workers have the opportunity to purchase them in sufficient quantities at $100 per canopy. Currently Ajay Metal Workers makes the canopies for 300 trailers per year at the following costs:

Material $40 Direct Labour $30 Variable overhead $20 Fixed overhead $25

A saving of 20% of fixed overhead would occur if the components were bought in. Should the component be bought in, and why?

a) No, increased cost of $5 per canopy.

b) No, increased cost of $10 per canopy.

c) Yes, cost savings of $5 per canopy.

d) Yes, cost savings of $10 per canopy.

Answer 1

Solution:

Per unit Analysis of Differential Cost - Ajay Metal Workers
Particulars	Make Canopy	Buy Canopy	Net Income Increase (Decrease)
Costs:
Direct material	$40.00	$0.00	$40.00
Direct Labor	$30.00	$0.00	$30.00
Variable overhead	$20.00	$0.00	$20.00
Avodiable fixed overheaed	$5.00	$0.00
Purchase price	$0.00	$100.00	-$100.00
Total Cost	$95.00	$100.00	-$5.00

As there is increase in cost by $5 if component is bought in therefore, company should not buy canopies due to increased cost of $5 per canopy.

Hence option a is correct.