Juanita Company must decide whether to make or buy some of its components for the

appliances it produces. The costs of producing 166,000 electrical cords for its appliances
are as follows.
Direct materials
Direct labor
Variable overhead
Fixed overhead

$90,000
$20,000
$32,000
$24,000

Instead of making the electrical cords at an average cost per unit of $1.00 ($166,000 /
166,000), the company has an opportunity to buy the cords at $0.90 per unit.
If the company purchases the cords, all variable costs and one-fourth of the fixed costs
will be eliminated.
(a) Prepare an incremental analysis showing whether the company should make or buy
the electrical cords.
(a1)what are the costs that change?
(b) Will your answer be different if the released productive capacity will generate
additional income of $5,000?
(b1) Recognize that opportunity cost can make a difference.
(a)
Make
Direct materials
$ 90,000
Direct labor
20,000
Variable manufacturing costs 32,000
Fixed manufacturing costs 24,000
Purchase price
0
Total cost
$166,000

Buy
$ 0
0
0
18,000*
149,400**
$167,400

Net Income
Increase (Decrease)
$ 90,000
20,000
32,000
6,000
(149,400)
$ (1,400)

*.75 3 $24,000
**$166,000 3 .90
This analysis indicates that Juanita Company will incur $1,400 of additional costs if it
buys the electrical cords rather than making them.
(b)
Total cost
Opportunity cost
Total cost

Make
$166,000
5,000
$171,000

Buy
$167,400
0
$167,400

Net Income
Increase (Decrease)
$(1,400)
5,000
$ 3,600

Yes, the answer is different: The analysis shows that net income will be increased by
$3,600 if Juanita Company purchases the electrical cords rather than making them

Accept an Order at a Special Price

Sunbelt Company produces 100,000 Smoothie blenders per month, which is 80% of plant
capacity. Variable manufacturing costs are $8 per unit. Fixed manufacturing costs are
$400,000, or $4 per unit. The Smoothie blenders are normally sold directly to retailers at
$20 each. Sunbelt has an offer from Kensington Co. (a foreign wholesaler) to purchase an
additional 2,000 blenders at $11 per unit. Acceptance of the offer would not affect normal
sales of the product, and the additional units can be manufactured without increasing
plant capacity. What should management do? If management makes its decision on the
basis of the total cost per unit of $12 ($8 variable 1 $4 fi xed), the order would be rejected
because costs per unit ($12) would exceed revenues per unit ($11) by $1 per unit.
However, since the units can be produced within existing plant capacity, the special order
will not increase fi xed costs. Lets identify the relevant data for the decision. First, the
variable manufacturing costs will increase $16,000 ($8 3 2,000). Second, the expected
revenue will increase $22,000 ($11 3 2,000). Thus, as shown in Illustration 7-4, Sunbelt
will increase its net income by $6,000 by accepting this special order.