Paper Moon, a manufacturer of outdoor lighting fixtures is operating at less than full capacity. The plant manager is considering making the mounting brackets now being purchased from a supplier at $8 each. Paper Moon already has the equipment to produce the brackets. The plant manager has analyzed the cost of producing the brackets and determined that each bracket will require $2 of direct material, $1 of direct labor, and $8 of manufacturing overhead. Seventy-five percent of the manufacturing overhead is a fixed cost that would not be affected by the decision to manufacture the brackets. Should Paper Moon continue to purchase the brackets or produce them internally?

To determine whether or not the fixtures should be manufacture purchased, we will compare the variable cost of making internally to the external purchase price.

Variable cost of making = 2 + 1 + (25%× 8)= $5

Note that the fixed manufacturing cost represents a cost that would be incurred irrespective of the decision taken. Hence it is considered. Only the variable portion is relevant.

Variable cost of making $5

External purchase price $8

Saving in cost by making $3

The fixtures should be purchased because it will save the Paper Moon by $3 per unit