I have two alternatives and what we'd like to do is determine

the additional revenues and costs that are associated with each alternative,

and then we'll look at what that means about profit and we would

prefer from a financial standpoint that alternative that gives us the most profit.

All right, so we're talking about 2,000 gift bags here.

If we make those 2,000 gift bags,

we would definitely be able to sell them and get some additional revenues.

But think about this,

if we buy those 2,000 gift bags,

we would also generate

some additional revenues and we would expect the revenues to be exactly the same,

regardless of whether we make

the bags or buy the bags from the supplier, and then sell them.

Okay. So we could put the revenues here that we would earn,

we could put the revenues here and we would recognize there's no difference,

or we could just start by recognizing there's no difference

and not worry about them because they're not relevant to the decision.

So we'll make our decision based on the difference in costs only.

If we make these bags,

the cost that we would incur would be

the additional variable cost associated with making them.

Remember now, if we make these 2,000 bags,

we're not going to incur more fixed cost.

We'll just incur more variable cost.

Let's look and see how much that is.

Direct material.

Oh, this is looking familiar, right?

We've seen this before.

Direct labor, variable manufacturing overhead, variable selling cost.

Those are our variable costs in this situation.

They total to $16.50.

So if we make these bags,

we'll incur an additional $16.50 per bag in cost.

There's 2,000 bags, so that would be in total $33,000 additional cost.

Now if we buy the bags, we have a different cost.

We'd be paying $19 for each of

those bags and that

would come to a total of $38,500 for the 2,000 bags.

Now notice if we had taken this $21 per unit cost,

which included the fixed cost and assume that we would

incur an additional $21 here, this, by alternative,

would have looked preferable to the make alternative,

but it's recognizing that we don't incur

any additional fixed cost and we only incur

the variable cost that allows us to see that we're

better off if we make these bags.

So, we are actually

$5,000 worse off if we choose to buy.

So our preferred alternative is to make the bags.