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:

The fixed overhead is an allocated expense; none of it would be eliminated if production of component DA stopped.

Required:
1. What are the alternatives facing Arches Manufacturing with respect to production of component DA?
2. List the relevant costs for each alternative. 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)?
3. Which alternative is better?

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