Question

# Talboe Company makes wheels which it uses in the production of children's wagons. Talboe's costs to...

Talboe Company makes wheels which it uses in the production of children's wagons. Talboe's costs to produce 200,000 wheels annually are as follows: Direct material...................................... \$40,000 Direct labor......................................... 60,000 Variable manufacturing overhead......... 30,000 Fixed manufacturing overhead............. 70,000 Total.................................................. \$200,000 An outside supplier has offered to sell Talboe similar wheels for \$0.80 per wheel. If the wheels are purchased from the outside supplier, \$25,000 of annual fixed manufacturing overhead would be avoided and the facilities now being used to make the wheels would be rented to another company for \$55,000 per year. If Talboe chooses to buy the wheel from the outside supplier, then the change in annual net operating income is a: Multiple Choice \$50,000 decrease \$70,000 increase \$40,000 increase \$50,000 increase

Total cost of manufacturing

= \$200,000

Cost per wheel = 200,000 / 200,000 = \$1

Purchase price= \$ 0.80

Net gain

= (1 - 0.80)*200,000

= \$40,000

Total fixed cost

=\$ 70,000

Fixed cost that can be avoided = \$25,000

Fixed cost to be incurred even if purchased from outside

= 70,000 - 25,000

= \$45,000

Gain from renting the property

= \$55,000

Therefore net affect on net operating income

= Gain on purchasing - Fixed cost to be incurred + rent income

= 40,000 - 45,000 + 55,000

= \$50,000

Therefore the net income of Talboe Company will increase by \$50,000 after accepting the offer.

Therefore the correct option is 4th i.e. \$50,000 increase.

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