Chesbrough, Inc., makes many of the components of its main product in-house. Recently, Berham Electronics offered to supply one component, K-25, at a price of $6.50 each. Chesbrough uses 20,000 units of component K-25 each year. The absorption cost per unit of this component is as follows:
|
Direct materials
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$2.95
|
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Direct labor
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0.40
|
|
Variable overhead
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1.80
|
|
Fixed overhead
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4.00
|
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Total
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$9.15
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The fixed overhead is an allocated expense; none of it would be eliminated if pro- duction of component K-25 stopped.
Required
1. What are the alternatives facing Chesbrough, Inc., with respect to production of component K-25?
2. List the relevant costs for each alternative. Suppose that Chesbrough, Inc., purchases K-25 from Berham Electronics. By how much will operating income increase or decrease?