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Make or buy decision and relevant cost

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Davis Company manufactures used parts in production of widgets. When 10,000 items are produced, the costs per unit are:

Direct Materials $0.50
Direct Manufacturing labor 2.00
Variable manufacturing overhead 1.20
Fixed manufacturing overhead 1.60

Jackson Company has offered to sell to Davis Company, 10,000 units of the part for 5.00 per unit. The facility could be used to manufacture another item at a savings of $9,000 if Davis Company accepts the offer. In addition, 1.00 per unit of fixed manufacturing overhead on the original item would be eliminated.

a. What is the relevant per unit cost for the original part?

b. Which alternative is best for Davis Company? By how much?

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The solution explains how to determine the relevant cost for a make or buy decision

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a. What is the relevant per unit cost for the original part?

Relevant costs are the costs that change due to the decision. The relevant costs are
Direct Materials $0.50 ...

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