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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

Direct labor 6

Variable manufacturing overhead


Fixed manufacturing overhead, traceable 3*

Fixed manufacturing overhead, common, but allocated


Total cost
*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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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.

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2. What qualitative factors might influence the decision about whether to make or to buy the component?

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