Question

Make-or-Buy Decision

Fremont Computer Company has been purchasing carrying cases for its portable computers at a purchase price of $61 per unit. The company, which is currently operating below full capacity, charges factory overhead to production at the rate of 45% of direct labor cost. The unit costs to produce comparable carrying cases are expected to be as follows:

Direct materials	$30
Direct labor	21
Factory overhead (45% of direct labor)	9.45
Total cost per unit	$60.45

If Fremont Computer Company manufactures the carrying cases, fixed factory overhead costs will not increase and variable factory overhead costs associated with the cases are expected to be 13% of the direct labor costs.

a. Prepare a differential analysis dated September 30 to determine whether the company should make (Alternative 1) or buy (Alternative 2) the carrying case. If required, round your answers to two decimal places. If an amount is zero, enter "0". Use a minus sign to indicate a loss.

Differential Analysis
Make Carrying Case (Alt. 1) or Buy Carrying Case (Alt. 2)
September 30
	Make Carrying Case (Alternative 1)	Buy Carrying Case (Alternative 2)	Differential Effect on Income (Alternative 2)
Sales price	$	$	$
Unit costs:
Purchase price
Direct materials
Direct labor
Variable factory overhead
Fixed factory overhead
Income (Loss)	$	$	$

Answer 1

Differential Analysis
Make Carrying Case (Alt. 1) or Buy Carrying Case (Alt. 2)
30-Sep
	Make Carrying Case (Alternative 1)	Buy Carrying Case (Alternative 2)	Differential Effect on Income (Alternative 2)
Sales price	0	0	0
Unit costs:
Purchase price	0	-61	-61
Direct materials	-30	0	30
Direct labor	-21	0	21
Variable factory overhead	-2.73	0	2.73
Fixed factory overhead	-6.72	-6.72	0
Income (Loss)	- $60.45	- $67.72	- $7.27

variable factory overhead = 13% of direct labor costs

= 21 x 13 %

= $ 2.73

Fixed factory overhead = Total factory overhead - Variable factory overhead

= 9.45 - 2.73

= $ 6.72

The cost of machinery is $ 6.72 less then cost of buying. Hence it is better to make.

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