Wilma Company must decide whether to make or buy some of its components. The costs of producing 60,000 switches for its generators are as follows.

Direct materials $29,000

Variable overhead $44,000

Direct labor $25,000

Fixed overhead $76,000

Instead of making the switches at an average cost of $2.90 ($174,000 : 60,000), the company has an opportunity to buy the switches at $2.65 per unit. If the company purchases the switches, all the variable costs and one-fourth of the fixed costs will be eliminated.

Prepare an incremental analysis showing whether the company should make or buy the switches.

Wilma Company should produce internally as this will savings of $42,000.

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 ($2.65 * 60,000) 159000

Variable cost - (29,000 + 44,000 + 25,000) = 98000

Extra variable cost of external purchase (61000)

Savings in Avoidable fixed cost (1/4 * 76,000) 19,000

Net extra cost of external purchase (42000)

Wilma Company should produce internally as this will savings of $42,000.