James Lighting manufactures switches that it uses in several of its products. Management is con- sidering whether to continue manufacturing the switches or to buy them from an outside source. The following information is available:

 

1.   The company needs 100,000 switches per year. Switches can be purchased from an outside supplier at a cost of $4 per unit.

 

2.   The cost of manufacturing switches is $5 per unit, computed as follows:

 

 

 

Direct materials  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	$150,000
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	100,000
Manufacturing overhead:	Â
Variable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	200,000
Fixed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	    50,000
Total manufacturing costs  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	$500,000
Cost per unit ($500,000 -;- 100,000 units) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	$5.00

 

 

 

 

 

3.   Discontinuing the manufacture of the switches will eliminate all of the direct materials and direct labor costs but will eliminate only 70 percent of the variable overhead costs.

 

4.   If the switches are purchased from an outside source, certain machinery used in the pro- duction process would no longer have to be leased. Accordingly, $19,000 of fixed overhead costs could be avoided. No other reduction will result from discontinuing production of the switches.

 

 

 

 

 

 

Instructions

a.       Prepare a schedule to determine the incremental cost or benefit of buying switches from the outside supplier. On the basis of this schedule, would you recommend that the company manu- facture the switches or buy them from the outside source?

 

b.       Assume that if switches are purchased from the outside source, the factory space previously used to produce switches can be used to manufacture an additional 10,000 dimmers per year. These dimmers have an estimated contribution margin of $14 per unit. The manufacture of the additional dimmers would have no effect on fixed overhead. Would this new assumption change your recommendation as to whether to make or buy switches? In support of your con- clusion, prepare a schedule showing the incremental cost or benefit of buying switches from the outside source and using the factory space to produce additional dimmers.