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Relevant cost of buying a component

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Climate-Control, Inc., manufactures a variety of heating and air-conditioning units. The company is currently manufacturing all of its own component parts. An outside supplier has offered to sell a thermostat to Climate-Control for $14 per unit. To evaluate this offer, Climate-Control, Inc., has gathered the following information relating to its own cost of producing the thermostat internally:

Per Unit 15,900 Units
per year
Direct materials $4
$63,600

Direct labor 6
95,400

Variable manufacturing overhead
3

47,700

Fixed manufacturing overhead, traceable 3*
47,700

Fixed manufacturing overhead, common, but allocated
8

127,200

Total cost
$24
$381,600
*20% supervisory salaries; 80% depreciation of special equipment (no resale value).

Requirement 1:
(a) What will be the total relevant cost of 15,900 units, if they are manufactured internally?

Total relevant cost = $______________

Requirement 2:
Suppose that if the thermostats were purchased, Climate-Control, Inc., could use the freed capacity to launch a new product. The segment margin of the new product would be $61,000 per year.

(a) What will be the total relevant cost of 15,900 units, if they are manufactured internally?

Total relevant cost = $_________________

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https://brainmass.com/economics/labour-economics/relevant-cost-buying-component-236861

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Solution Summary

The solution explains how to calculate the relevant cost of making or buying a component.

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Assume that a division of Bose makes an electronic component for its speakers. Its manufacturing process for the component is a highly automated part of a just-in-time production system. All labor is considered to be an overhead cost, and all overhead is regarded as fixed with respect to output volume.

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A small, local company has offered to supply the components at a price of $3.30 each. If the division discontinued its production of the component, it would save two-thirds of the supplies cost and $30,000 of indirect-labor cost. All other overhead costs would continue.

The division manager recently attended a seminar on cost behavior and learned about fixed and variable costs. He wants to continue to make the component because the variable cost of $3.00 is below the $3.30 bid.

1. Compute the relevant cost of (a) making and (b) purchasing the component. Which alternative is less costly and by how much?
2. What qualitative factors might influence the decision about whether to make or to buy the component?

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