Question

Damon Industries manufactures 30,000 components per year. The manufacturing costs of the components was determined as follows:

Direct materials	$	150,000
Direct labor		170,000
Variable manufacturing overhead		70,000
Fixed manufacturing overhead		90,000

An outside supplier has offered to sell the component for $14. If Damon purchases the component from the outside supplier, the manufacturing facilities would be unused and could be rented out for $11,000. If Damon purchases the component from the supplier instead of manufacturing it, the effect on operating profits would be a:

• $19,000 decrease

• $41,000 increase

• $49,000 decrease

• $89,000 increase

Answer 1

Rental Expenses , Depreciation on Machinary are already incurred Costs (like sunk costs) and these costs are irrelevant for decision making Buy Incremental Cost (Savings) $ 150,000.00 $ 170,000.00 $ 70,000.00 $ $ - Make Direct Materials $ 150,000.00 Direct Labor $ 170,000.00 Variable Manufacturing Overhl $ 70,000.00 Fixed Manufacturing Overhead Opportunity Cost of renting Manufacturing Facilities $ 11,000.00 $ 11,000.00 Cost of Component from Outside Supplier (30000x$14) $ 420,000.00 $ (420,000.00) $ - $ $ 401,000.00 $ 420,000.00 $ (19,000.00) Total Costs Operating Profit Will decreased by $19000 if Damon purchased from supplier instead of manufacturing it. So Option 1 is Correct Answer.