Question

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

Answer 1

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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