Waterways has discovered that a small fitting it now manufactures at a cost of $

Question

Waterways has discovered that a small fitting it now manufactures at a cost of $1.00 per unit could be bought elsewhere for $0.82 per unit. Waterways has fixed costs of $0.20 per unit that cannot be eliminated by buying this unit. Waterways needs 460,000 of these units each year.

If Waterways decides to buy rather than produce the small fitting, it can devote the machinery and labor to making a timing unit it now buys from another company. Waterways uses approximately 500 of these units each year. The cost of the unit is $12.66. To aid in the production of this unit, Waterways would need to purchase a new machine at a cost of $2,345, and the cost of producing the units would be $9.90 a unit.

What is Waterways’ opportunity cost if it chooses to buy the small fitting and start manufacturing the timing unit?

Would it be wise for Waterways to buy the fitting and manufacture the timing unit? Explain

Explanation / Answer

Fixed Cost Not Eliminated
       $ 92 000

Total Annual Cost
$ 460 000
$ 469 200
(9200)

(2) Would it be wise for wise for Waterways to buy the fitting and manufacture the timing unit? Explain

Make
Buy
Net Income
Manufacturing Cost
$460 000

$ 460 000
Purchase

$377 200
$ (377 200)
Fixed Cost Not Eliminated

$ 92 000
$ (92 000)
Total Annual Cost
$ 460 000
$ 469 200
(9200)
Opportunity cost
$ 1380
0
$ 1380
Total cost
$ 461 380
$ 469 200
($ 7820)

If Waterways adds that amount to the cost of making the small fitting, the total cost still less than buying cost. The company would manufacturing the small fitting and buy the timing units.

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