Question

Part N19 is used by Malouf Corporation to make one of its products. A total of 7,000 units of this part are produced and used every year. The company's Accounting Department reports the following costs of producing the part at this level of activity:
Per Unit

Direct materials
$2.20

Direct labor
$8.50

Variable manufacturing overhead
$1.30

Supervisor’s salary
$5.80

Depreciation of special equipment
$7.20

Allocated general overhead
$4.60


An outside supplier has offered to make the part and sell it to the company for $24.50 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including the direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company, none of which would be avoided if the part were purchased instead of produced internally. In addition, the space used to make part N19 could be used to make more of one of the company's other products, generating an additional segment margin of $25,000 per year for that product. What would be the impact on the company's overall net operating income of buying part N19 from the outside supplier?

A. Net operating income would increase by $25,000 per year.
B. Net operating income would decline by $10,700 per year.
C. Net operating income would decline by $60,700 per year.
D. Net operating income would decline by $21,900 per year.

Answer 1

Answer:

D) Net operating income would decline by $21,900 per year.

Explanation:

The malouf cooperation produces 7000 parts a year.

Production costs are as follows:

•Direct materials = $2.20

•Direct labor = $8.50

•Variable manufacturing overhead

= $1.30

•Supervisor’s salary =$5.80

•Depreciation of special equipment=$7.20

•Allocated general overhead=4.60

If the company decides to buy from an outside supplier, they would generate $25,000 per year by producing another product using the freed space.

They will also cut down expenses on variable costs, such as:

Supervisor's salary = $5.50

Direct materials = $2.20

Direct labor = $8.50

Variable manufacturing = $1.30

Total cost avoided per product= ($5.50+$2.20+$8.50+$1.30)

= $17.80 per product.

Since the supplier's price is $24.50 per product, the company would be at loss of ($17.80 - $24.50) $6.70 per product if they buy from the supplier.

Total loss per year would be=

-$6.70 * 7000 = -$46,900

(it's negative because it's at loss)

When we add -$46,900 with the $25,000 per year that would be generated if the the company buys from the outside supplier, we have:

-$46,900 + $25,000

= -$21,900

Hence, there would be a decline of $21,900 per year in the company's net operating income