Refer to the information for Zion Manufacturing above. Assume that 75 percent of Zion Manufacturing’s fixed overhead for Component K2 would be eliminated if that component were no longer produced.
Zion Manufacturing had always made its components in- house. However, Bryce Component Works had recently offered to supply one component, K2, at a price of $ 25 each. Zion uses 10,000 units of Component K2 each year. The cost per unit of this component is as follows:
Direct materials ......... $ 12.00
Direct labor ............8.25
Variable overhead ........4.50
Fixed overhead .........2.00
Total .............. $ 26.75
Required:
1. Conceptual Connection: If Zion decides to purchase the component from Bryce, by how much will operating income increase or decrease? Which alternative is better?
2. Briefly explain how increasing or decreasing the 75 percent figure affects Zion’s final decision to make or purchase the component.
3. By how much would the 75 percent figure have to decrease before Zion would be indifferent (i. e., incur the same cost) between “making” versus “purchasing” the component? Show and briefly explain your calculations.