Ring Company makes telephones. Currently, Ring makes all components of the telep

Question

Ring Company makes telephones. Currently, Ring makes all components of the telephones in-house. An outside company has offered to supply one component, part number X76, for $12 each. Ring uses 22,000 of these components per year. Costs of X76 are as follows: Direct materials $3.00 Direct labor $1.50 Variable overhead $2.75 Fixed overhead $5.00 Suppose that 30% of the fixed overhead is avoidable if part X76 is not made by Ring. Should Ring purchase the part from the outside supplier A. No, income will decrease by $71,500. B. No, income will decrease by $15,000. C. Yes, income will increase by $74,500 D. No, income will decrease by $10,500.

Explanation / Answer

Answer: A. No, income will decrease by $71,500.

=> If we purchase the component from outside, the total cost incurred by Ring = $12 (purchase cost) + Unavoidable fixed cost ($5 * 0.70) = 12 + 3.50 = $15.50

If Ring made the component = 3 + 1.50 + 2.75 + 5 = $12.25

Excess cost incurred on purchased of component = $15.50 - $12.25 = $3.25

The income will decrease by = $3.25 * 22000 = $71500, so Ring should not purchase the part from outside.

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