Make$-$or$-$Buy Decision

Arches Manufacturing had always made its components in$-$house. However, Canyonlands Component Works had recently offered to supply one component, DA$,$ at a price of $$52$ each. Arches uses $12,000$ units of component DA each year. The cost per unit of this component is as follows:

Line Item Description Amount

Direct materials $$25\mathrm{.}00$

Direct labor $6\mathrm{.}25$

Variable overhead $15\mathrm{.}75$

Fixed overhead $9\mathrm{.}00$

Total $$56\mathrm{.}00$

Assume that $80\%$ of Arches Manufacturing's fixed overhead for component DA would be eliminated if that component were no longer produced.

Required:

$1.$ Conceptual Connection: If Arches decides to purchase the component from Canyonlands, by how much will operating income increase or decrease $($as compared to making the component in$-$house$)?$

fill in the blank $1$ of $1$$

Which alternative is better?

$2.$ Conceptual Connection: Briefly explain how increasing or decreasing the $80\%$ figure affects Arches's final decision to make or purchase the component.

As the percentage of avoidable fixed cost increases $($above $80\%),$ total relevant costs of making the component increase, causing the "purchase" decision to be fill in the blank $1$ of $5$

financially appealing $($compared to the "make" option$)$ than it was when the percentage was $80\%.$ In other words, as the percentage increases, difference between the "purchase" and "make" options increases resulting in the "purchase" decision being even fill in the blank $2$ of $5$

attractive. Alternatively, as the percentage of avoidable fixed costs decreases, the "make" option eventually is fill in the blank $3$ of $5$

costly and fill in the blank $4$ of $5$

appealing financially as the "purchase" option. Finally, as the percentage of avoidable fixed cost decreases low enough and the total relevant costs of making the component decrease, the fill in the blank $5$ of $5$

option becomes the more financially appealing option

$3.$ Conceptual Connection: By what dollar amount would the per$-$unit relevant fixed cost have to decrease before Arches would be indifferent $($i$.$e$.,$ incur the same cost$)$ between "making" versus "purchasing" the component?

fill in the blank $1$ of $1$$