Your Company makes 35,000 motors to be used in the production of its sewing machines. The cost per motor at this level of activity is:
Direct materials $4.50
Direct labor $4.60
Variable manufacturing overhead $3.75
Fixed manufacturing overhead $3.40
An outside supplier has offered to supply all the motors the company needs for $15 each. If Your Company decides to buy the motors, there would be no other use for the production facilities and 25% of the fixed manufacturing overhead cost could not be avoided. If Your Company decides to buy the motor, what is the change in net income net operating income?
B. $ 14,000
Cost of production of motor :
= Direct materials + Direct labor + Variable manufacturing overhead + Fixed manufacturing overhead
= 4.5 + 4.6 + 3.75 + 3.4 = $ 16.25 per motor
Cost of purchase of motor :
= Purchase cost + unavoidable fixed manufacturing overhead
= 15 + 25%(3.4) = $ 15.85 per motor
If company decided to purchase motor : net income would be,
= 16.25 - 15.85 = $ 0.40 per motor
Net income would be = 35,000 motors × $ 0.40 per motor
= $ 14,000
Hence, option "B" is correct.
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