Zorro Manufacturing had always made its components in house. However, Simpson Components Works had recently offered to supply one component, P7-43, at a price of $5 each. Zorro uses 3,850 units of component P7-43 each year. The absorption cost per unit of this component is as follows:
- Direct Materials $1.30
- Direct Labor .65
- Variable Overhead 2.50
- Fixed Overhead 3.00
- Total $7.45
The fixed overhead is an allocated expense; none of it would be eliminated if production of component P7-43 stopped.
Required:
a. What are the alternatives facing Zorro Manufacturing with respect to production component P7-43?
b. List the relevant cost for each alternative. Which alternative is better?