Gelb Company currently manufactures 41,000 units per year of a key component for its manufacturing process. Variable costs are $4.05 per unit, fixed costs related to making this component are $83,000 per year, and allocated fixed costs are $78,500 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 $3.50 per unit. Calculate the total incremental cost of making 41,000 units and buying 41,000 units. Should it continue to manufacture the component, or should it buy this component from the outside supplier

Answer and Explanation:

1. The computation of total incremental is shown below:-

                                Incremental Costs to Make

                      Relevant Amount     Relevant Fixed  Total Relevant

                         Per Unit                           Costs                  Costs

Variable Cost

Per Unit              $4.05                                                   $166,050

                                                                                (41,000 × $4.05)

Fixed manufacturing

cost                                          $83,000                       $83,000

Total incremental

cost to make                                                                $249,050

Incremental Costs to Buy

                  Purchase Price    Relevant Fixed    Total Relevant

                   Per Unit                  Costs                      Costs

Purchase Price

Per Unit                                                                  $143,500

                                                                          ($3.50 × 41,000)

Total Incremental Cost to Buy                             $143,500

2. The company should buy  from the outside supplier as its a lower and the total incremental cost is $143,500