Engstrom, Inc., uses 10,000 pounds of a specific component in the production of

Question

Engstrom, Inc., uses 10,000 pounds of a specific component in the production of life preservers each year. Presently, the component is purchased from an outside supplier for $11 per pound. For some time now, the factory has had idle capacity that could be utilized to make the component. Engstrom's costs associated with manufacturing the component are as follows: Direct material per pound: $3 Direct Labor per pound $3 Variable Overhead per Pound $2 Fixed Overhead per unit (based on annual production of 10,000 pounds) $2 In addition, if the component is manufactured by Engstrom, the company will hire a new factory supervisor at an annual cost of $32,000. Required: If Engstrom chooses to make the component instead of buying it from the outside supplier, what would be the change, if any, in the company's income?

Explanation / Answer

Incremental cost on making the component = ($3 + $3 + $2) x 10000 + $32000 = $80000 + $32000 = $112000 Incremental cost if purchased from supplier = $11 x 10000 = $110000 Hence incremental Loss = $112000 - $110000 = $2000 If Engstrom chooses to make the component instead of buying it from the outside supplier,the company's income reduces by $2000

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