Below is an example problem implementing a classic "make-versus-buy" analysis where a company needs to decide whether it's more advantageous to manufacture a part internally within its overall operation or instead simply purchase the same part, in quantity, from an outside supplier. Remember when looking at the given data that we'll need to focus on what's relevant (i.e., what will be the different costs) if we MAKE the part in-house or instead BUY the part from the outside supplier. It will be well worth your time to take a good look at this problem, think about it, and circle back later to make sure you understand how the analysis is done. Once you understand this, you'll probably have a reasonably good grasp on how to approach an incremental analysis problem and think it through. Here's the problem, and don't be afraid to give it a good try and show us your analysis along with your answer. Many people can try this at once...
Palumbo Plumbing Parts, Inc., internally produces a small electronic sensor unit that it installs into each of its automatic "hands-free" chrome bathroom faucets manufactured at its Harlingen, Texas, plant. The company's unit product cost for this small sensor unit, based on a production level of 100,000 units per year, is as follows:
.........................................................Per part ............Total
Direct Materials................................. $3.50............$350,000
Direct Labor .......................................3.00............$300,000
Variable Manufacturing Overhead............1.00............$100,000
The company also incurs the following fixed costs annually:
Fixed Manufacturing Overhead (Traceable or Avoidable) is $200,000 TOTAL and equal to $2 per sensor unit.
Fixed Manufacturing Overhead (Common---not traceable to any specific product in the factory, and these costs will remain even if no sensor units are locally manufactured); these common fixed manufacturing overhead costs are allocated to the product line at $2.50 per sensor unit or $250,000 TOTAL.
Unit Product Cost for each sensor unit:
$12.00 per unit (comprised of the following costs)...
$3.50 + $3 + $1 = Variable Cost of $7.50 per unit PLUS $2 + $2.50 = Fixed Cost of $4.50 per unit
Now here's the deal: an outside electronics supplier in nearby McAllen, Texas, has offered to sell the same electronic sensor units to Palumbo Plumbing Parts for only $10 apiece, so it looks like Palumbo could possibly save $2.00 per unit if it buys the electronic sensor parts instead of making them in their own factory!
In Palumbo's current operation, 100 percent (ALL) of the traceable or avoidable fixed manufacturing overhead costs are comprised of supervisor salaries and other costs that can be ELIMINATED if the sensor units are purchased from the outside supplier. However, the decision to buy the parts from the outside supplier would have NO effect on the common fixed manufacturing overhead costs of the company, and the space being used to produce the sensor units at Palumbo's factory in Harlingen would otherwise be idle. Ignore the impact of income taxes in your calculation.
(a) How much would Palumbo's annual profits increase or decrease if it decides to purchase the sensor units from the outside supplier rather than making them inside the company? Please be sure to show your calculations supporting your answer.