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Impala is currently producing 100 units of a necessary component part by incurring $42,000 in direct materials, $8,750 in direct labor, $15,750 in variable overhead, and $10,500 in fixed overhead. Impala can purchase the component externally for $66,500 and $1,750 of fixed costs can be avoided. What should Impala do, and why?

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Answer:

If Impala decides to buy from the external source , it would then save the fixed of $1,750

Decision: Impala should be buy from the external source

Explanation:

To determine the appropriate course of action, we shall determine whether there would be a net savings in cash flow as a result of purchasing externally or not.

The relevant cash flows figures include:

  1. Internal variable cost of production
  2. External purchase price
  3. Savings in internal; fixed cost as result of buying outside

Variable cost of internal production = 42,000 + 8,750 + 15,750 = 66,500

Increase in variable cost if purchased externally = 66500 - 66500 = 0

If Impala decides to buy from the external source , it would then save the fixed of $1,750

Decision: Impala should be buy from the external source

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