Zion Manufacturing had always made its components in-house. However, Bryce Component Works had recently offered to supply one component, K2, at a price of $25 each. Zion uses 10,000 units of Component K2 each year. The cost per unit of this component is as follows:
Direct materials $12.00
Direct labor $8.25
Variable overhead $4.50
Fixed overhead $2.00
The fixed overhead is an allocated expense; none of it would be eliminated if production of Component K2 stopped.
1. What are the alternatives facing Zion Manufacturing with respect to production of Component K2?
2. List the relevant costs for each alternative. If Zion decides to purchase the component from Bryce, by how much will operating income increase or decrease? Which alternative is better?