Question 25 (4 points) B Company makes 40,000 motors annually to be used in the

Question

Question 25 (4 points)

B Company makes 40,000 motors annually to be used in the production of its power lawn mowers. The manufacturing cost per motor at this level (40,000 units) of activity is as follows:

This motor has recently become available from an outside supplier for $25 per motor. If B decides not to make the motors, 50% of the fixed manufacturing overhead could be avoided and the space used to make the motors could be rented to a tenant for $15,000 per year. If B decides to continue making the motor, how much higher or lower will the company's net operating income be than if the motors are purchased from the outside supplier?

Direct Materials $9.00 Direct labor $7.00 Variable Manufacturing Overhead $5.00 Fixed Manufacturing Overhead $6.00

Explanation / Answer

Calculation of Relevant cost:- Make the Product Buy the Product Direct materials (40,000*9)        360,000 Purchase price (40,000*25) 1,000,000 Direct labor (40,000*7)        280,000 Less : Rent from tenant        15,000 Variable manufacturing overhead ((40,000*5)        200,000 Avoidable fixed manufacturing overhead        120,000 [(40,000*(6*50%)] Relevant cost to make the product        960,000 Relevant cost to buy the product      985,000 Hence, B's net operating income will be higher by $(985,000-960,000) = $25,000 if he continues to make the motor.

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