Currently, GreenCut Lawn mowers produces all of its riding lawn mower transmissions in-house. Annual costs for producing these 45,000 transmissions are detailed below: Instead of making its own transmissions, GreenCut is considering buying them from a supplier at a cost of $30 each. Based on incremental analysis, GreenCut should

Question:

Currently, GreenCut Lawnmowers produces all of the transmissions used in its riding lawnmowers in-house. Its annual costs for producing these 45,000 transmissions are detailed below:

Direct material                                                    765,000

Direct labor                                                          270,000

variable overhead                                                240,000              

Fixed manufacturing overhead                           150,000                

Total manufacturing cost                                  1,425,000

Instead of making its own transmissions, GreenCut is considering buying them from a supplier at a price of $30 each. Based on incremental analysis, GreenCut should

Green Cut should produce/make the transmission internally because doing so would it $15,000

Explanation:

For a make or buy decision the relevant cash flows include  

1. the differential variable of the two options  

2. savings from avoidable fixed costs associated with internal production  

Incremental analysis $

External cost of purchase( $30×  45,000)                                   1,350,000

Variable cost of making  

(765,000 + 270,000 + 250,000)                                                   (1,185,000 )

Extra variable cost of external purchase                                        165,000  

Savings in Avoidable fixed cost                                                       (150,000)

Net extra cost of external purchase cost                                         15,000

Note that the fixed manufacturing cost are unavoidable cost i.e which means they would be incurred either way.

Decision

Green Cut should produce/make the transmission internally because doing so would it $15,000

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