Sundown Sunglass Company currently manufactures the frames used in its sunglasse

Question

Sundown Sunglass Company currently manufactures the frames used in its sunglasses. Here are Sundown's most recent data regarding this key component part: 10,000 $300,000 $165,000 of frames produced annually Fixed production costs Variable production costs in lieu of manufacturing the frames in-house, Sundown can purchase the frames from an outside supplier. If Sundown purchases the frames from the outside supplier, it would avoid 35% of the fixed production costs. To maintain its current level of operating income, what is the highest price Sundown can pay the outside supplier for each frame? $10.50 $27.00 $1650 $36.50 None of the above

Explanation / Answer

Solution :The correct answer is the 2nd option i.e $ 27.00 / frame(See working note)

Working Note

Costs avoided by Purchasing the frames and not manufacturing it in house.

Fixed Cost( 35% of Total Production cost i.e 0.35*$3,00,000) =$ 1,05,000

Variable Cost of Manufacturing (100 % of $1,65,000) =$1,65.000

Total Avoidable Costs =$ 2,70,000

Total Number of Frames = 10,000 frames

Avoidable Cost /frame= $ 27/frame i.e the maximum price the company would pay for the frames is the Total Cost Avoided by not manufacturing the frames in house.

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