Sage Company is operating at 90% of capacity and is currently purchasing a part used in its manufacturing operations for $15 per unit. The unit cost for the business to make the part is $20 including fixed costs and $11 excluding fixed costs. If 30,000 units of the part are normally purchased during the year but could be manufactured using unused capacity, what would be the amount of differential cost increase or decrease from making the part rather than purchasing it

Answer: $120,000 decrease

Explanation:

Given the following;

Cost of purchasing the part = $20

Cost of manufacturing the part (excluding fixed cost) = $11

Cost of manufacturing the part (including fixed cost) = $20

Number of unit purchased = 30000

The $20 cost of manufacturing the part (including fixed cost) would be exempted from our calculation as fixed cost isn't directly related to the manufacturing cost of the part. Even if the part is purchased, fixed cost will still be the same.

Therefore,

Total cost of part when purchased =

30000 * $15 = $450,000

Total cost of part when manufactured = 30000 * $11 = $330, 000

Differential cost (making part and purchasing) = $330,000 - $450,000 = - $120,000

-$120,000 signifies a decrease.

The amount of differential cost decrease from making the part rather than purchasing it is $120,000

Explanation:

Consider the cost of making at $11 excluding the fixed costs. This is because the fixed costs are irrelevant as they are would exist whether the Making is made or Purchase is done instead

Thus the differential cost decrease on the the 30,000 units would be:

30,000 * (15-11)

30,000*$4

$120,000