Question

Make vs. Buy (Sourcing Decision) Eggers Company needs 37,000 units of a part to use in producing one of its products. If Eggers buys the part from McMillan Company for $100 instead of making it, Eggers will not use the released facilities in another manufacturing activity. Forty percent of the fixed overhead will continue irrespective of CEO Donald Mickey’s decision. The cost data are as follows:

Cost to make the part:
Direct materials	$	37
Direct labor		20
Variable overhead		28
Fixed overhead		20
	$	105

Required:

1. Determine which alternative is more attractive to Eggers, and by what amount.

Answer 1

Differential analysis

	Cost of making	Cost of buying	Increase/Decrease in income
Direct materials	37000 x 37 = 1,369,000	0	1,369,000
Direct labor	37,000 x 20 = 740,000	0	740,000
Variable overhead	37,000 x 28 = 1,036,000	0	1,036,000
Fixed overhead	37,000 x 20 = 740,000	296,000	444,000
Outside supplier's price	0	37,000 x 100 = 3,700,000	- 3,700,000
Total cost	$3,885,000	$3,996,000	- $111,000

Making is advantageous by $111,000.

Fixed overheads = $740,000

Unavoidable fixed overheads = 740,000 x 40%

= $296,000

Avoidable fixed overheads = Fixed overheads - Unavoidable fixed overheads

= 740,000 - 296,000

= $444,000

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