Gelb Company currently manufactures 58,500 units per year of a key component for its manufacturing process. Variable costs are $6.25 per unit, fixed costs related to making this component are $67,000 per year, and allocated fixed costs are $64,500 per year. The allocated fixed costs are unavoidable whether the company makes or buys this component. The company is considering buying this component from a supplier for $3.70 per unit.

Gelb Company currently manufactures 58,500 units per year of a key component for its manufacturing process. Variable costs are $6.25 per unit, fixed costs related to making this component are $67,000 per year, and allocated fixed costs are $64,500 per year. The allocated fixed costs are unavoidable whether the company makes or buys this component. The company is considering buying this component from a supplier for $3.70 per unit.
 
Calculate the total incremental cost of making 58,500 and buying 58,500 units. Should it continue to manufacture the component, or should it buy this component from the outside supplier?

Explanation

	Make			Buy
Variable costs (58,500 @ $6.25)	$	365,625
Incremental fixed costs		67,000
Cost to buy (58,500 @ $3.70)				$	216,450
Total	$	432,625		$	216,450

Recommendation: Note that the allocated fixed costs of $64,500 are not relevant to this managerial decision because they will continue whether the part is made or bought. Therefore, the incremental costs of making the part are $216,175 more per year than buying it. This implies that the company should buy the part from the outside supplier rather than make the part.