Arches Manufacturing had always made its components in-house. However, Canyonlands Component Works had recently offered to supply one component, DA, at a price of $50 each. Arches uses 100,000 units of component DA each year. The cost per unit of this component is as follows:

Assume that 80% of Arches Manufacturing’s fixed overhead for component DA would be eliminated if that component were no longer produced.

Required:
1. If Arches decides to purchase the component from Canyonlands, by how much will operating income increase or decrease (as compared to making the component in-house) Which alternative is better?
2. Briefly explain how increasing or decreasing the 80% figure affects Arches’s final decision to make or purchase the component.
3. By what dollar amount would the per-unit relevant fixed cost have to decrease before Arches would be indifferent (i.e., incur the same cost) between “making” versus “purchasing” the component? Show and briefly explain your calculations.

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Direct materials Direct labor Variable overhead Fixed overhead Total $25.00 6.25 15.75 5.00 $52.00