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    Make or Buy a Component

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    For many years, Diehl Company has produced a small electrical part that it uses in the production of its standard line of diesel tractors. The company's unit product cost for the part, based on a production level of 60,000 parts per year, is as follows:

    Per Part Total
    Direct materials $ 4.00
    Direct labor 2.75
    Variable manufacturing overhead 0.50
    Fixed manufacturing overhead, traceable 3.00 $ 180,000
    Fixed manufacturing overhead, common
    (allocated on the basis of labor-hours) 2.25 $ 135,000
    Unit product cost $ 12.50

    An outside supplier has offered to supply the electrical parts to the Diehl Company for only $10.00 per part. One-third of the traceable fixed manufacturing cost is supervisory salaries and other costs that can be eliminated if the parts are purchased. The other two-thirds of the traceable fixed manufacturing costs consist of depreciation of special equipment that has no resale value. Economic depreciation on this equipment is due to obsolescence rather than wear and tear. The decision to buy the parts from the outside supplier would have no effect on the common fixed costs of the company, and the space being used to produce the parts would otherwise be idle.

    How much would profits increase or decrease as a result of purchasing the parts from the outside supplier rather than making them inside the company. (Input the amount as positive value. Omit the "$" sign in your response.)

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    Solution Summary

    The solution explains the impact on profit of purchasing a part instead of making it.