All of the fixed manufacturing overhead costs would continue whether Part B89 is made internally or purchased from an outside supplier. Assume Lasso can purchase 10,000 units of the part from the Nadal Parts Company for $20.20 each, and the facilities currently used to make the part could be used to manufacture 10,000 units of another product that would have a $10 per unit contribution margin. If no additional fixed costs would be incurred, what should Lasso do?

Outsource the production of B89, manufacture the new product and buy the part from a vendor to earn an extra $5.10 per unit.

Explanation:

Lasso Corporation manufactures a variety of appliances which all use Part B89. Currently, Lasso manufactures Part B89 itself. It has been producing 10,000 units of Part B89 annually. The annual costs of producing Part B89 at the level of 10,000 units include the following:

Direct materials                                   $3.00

Direct labor                                          $8.10

Variable manufacturing overhead     $4.20

Fixed manufacturing overhead          $3.20

Total cost                                             $18.50

If Lasso decides to purchase Part B89 form a vendor, it will be able to save = direct material, direct labor and variable overhead = $3 + $8.10 + $4.20 = $15.30, and it will free the facility in order to produce another product that generates a $10 per unit contribution margin.

The decision to outsource production saves or generates = $15.30 + $10 = $25.30

The cost of outsourcing the production = $20.20

net impact = $25.30 - $20.20 = $5.10

Since the impact is positive, Lasso will earn a higher profit by outsourcing, so they should do it.

Make the new product and buy the part to earn an extra $5.10 per unit contribution to profit.

one of the appeals of a sole proprietorship is that business expenses are kept separate from your personal income tax return