Problem
Coleman Company owns a machine that produces a component for the products the company makes and sells. The company uses 1,800 units of this component in production each year. The costs of making one unit of this component are
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Direct material
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$ 7
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Variable manufacturing overhead
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6
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Direct labor
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4
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Fixed manufacturing overhead
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5
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The fixed overhead costs are unavoidable, and the unit cost is based on the present annual usage of 1,800 units of the component. An outside supplier has offered to sell Coleman this component for $18 per unit and can supply all the units it needs.
A. If Coleman buys the component from the outside supplier instead of making it, how much will net income change? Should Coleman make or buy the component? Use the incremental approach to justify your answer.
B. Suppose Coleman could rent the machine to another company for $5,000 per year. How would your response change to part A? Use the incremental approach to justify your answer.