New England Retrofitting Inc. (NERI)has been making a six point wiggle used in o

Question

New England Retrofitting Inc. (NERI)has been making a six point wiggle used in one of its products for the last ten years. Equipment and manufacturing space has been operating efficiently and a new lease was recently signed for another 3 years. The cost breakdown for each six point wiggle is as follows:

Direct Materials ............$14.50

Direct Labor..................$12.00

Variable Manufacturing Overhead $7.50

Fixed Manufacturing Overhead $120,000 annually or $12.00 per wiggle (based on 100,000 wiggles production).

Total Cost of Wiggle Production per year $4,600,000 or $46.00 per wiggle.

The Shake and Bake Company (SBC) has approached NERI with a proposal to provide the same wiggle that it makes at a price of $39.00 each with guaranteed delivery of 100,000 wiggle annually. What would be the net effect on Net Operating income if the offer from SBC was accepted? Based on this result, would you continue to make the wiggle or buy it from SBC?

Explanation / Answer

It is better to produce wiggle by NERI itself.

This is because variable cost is : $14.50 + $12.00 + $7.50 = $34.00

This cost will be saved by company, But it will continue to incurr fixed cost of 120,000 or $12

So effective new cost would be = $39 + $12 = $51 which is higher than earlier cost of $ 46 ( 34 + 12 )

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