Make-or-Buy Decision

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 $27 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	4.00
Total	$28.75

Assume that 75% of Zion Manufacturing's fixed overhead for Component K2 would be eliminated if that component were no longer produced.

Required:

1. CONCEPTUAL CONNECTION: If Zion decides to purchase the component from Bryce, by how much will operating income increase or decrease? Increase $

Which alternative is better? Purchase the component from Bryce

2. CONCEPTUAL CONNECTION: Briefly explain how increasing or decreasing the 75% figure affects Zions final decision 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 was 75%. In other words, as the percentage increases, difference between the purchase and make options increases resulting in the purchase decision being even more attractive. Alternatively, as the percentage of avoidable fixed costs decreases, the make option eventually is equally costly and as equally 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 make option becomes the more financially appealing option

3. CONCEPTUAL CONNECTION: By how much would the per-unit relevant fixed cost have to decrease before Zion would be indifferent (i.e., incur the same cost) between making versus purchasing the component?

$