Sydney Ltd has been making its own carry bags for the cameras it makes and sells.The company is presently operating at full capacity, and variable manufacturing overhead is charged to production at the rate of 70 per cent of direct labour cost.The direct costs of making one camera carry bag are: direct labour $6; direct materials $5.Normal production is about 30,000 camera carry bags per year.

A supplier has offered to make and supply the carry bags at a cost of $15.50 per unit.If this offer is accepted, Sydney Ltd will be able to eliminate all variable manufacturing costs incurred to make the bags.However, $45,000 of fixed manufacturing overhead costs per year that are currently charged to the bags will need to be reallocated to other products.

Requirements

(a)Prepare an incremental analysis showing the data relevant to the decision to make or buy the camera carry bags.On financial grounds, which decision would you recommend?

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(b)What qualitative factors may have to be considered before a final decision is made?

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(c)Assume that if Sydney Ltd decides to buy the bags it could use the manufacturing capacity made available by that decision to make another product.It is estimated that such activity would increase the company's net profit by $35,000.Would this change your answer to part (a)?

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