Make-or-Buy Decision: Zion Manufacturing had always made itscomponents in-house. However, Bryce Component Works had recentlyoffered to supply one component, K2, at a price of $28 each. Zionuses 12,500 units of Component K2 each year. The cost per unit ofthis component is as follows:
| Direct materials | $12.00 |
| Direct labor | 8.25 |
| Variable overhead | 4.50 |
| Fixed overhead | 6.00 |
| Total | $30.75 |
Assume that 75% of Zion Manufacturing's fixed overhead forComponent K2 would be eliminated if that component were no longerproduced.
Required:
1. CONCEPTUAL CONNECTION: If Zion decides topurchase the component from Bryce, by how much will operatingincome increase or decrease?
Which alternative is better?
Purchase the component from Bryce
2. CONCEPTUAL CONNECTION: Briefly explain howincreasing or decreasing the 75% figure affects Zion’s finaldecision to make or purchase the component.
As the percentage of avoidable fixed cost increases (above 75%),total relevant costs of making the component increase, causing the“purchase” decision to be more financially appealing(compared to the “make” option) than it was when the percentage was75%. In other words, as the percentage increases, differencebetween the “purchase” and “make” options increases resulting inthe “purchase” decision being even more attractive.Alternatively, as the percentage of avoidable fixed costsdecreases, the “make” option eventually isequally costly and as equally appealing financially asthe “purchase” option. Finally, as the percentage of avoidablefixed cost decreases low enough and the total relevant costs ofmaking the component decrease, the “make” option becomesthe more financially appealing option
3. CONCEPTUAL CONNECTION: By how much would theper-unit relevant fixed cost have to decrease before Zion would beindifferent (i.e., incur the same cost) between “making” versus“purchasing” the component? If necessary, round your answer to twodecimal places.
%
