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Detailed Explanation to Make or Buy

Question 2:

Rebelo Corporation is presently making part E07 that is used in one of its products. A total of 19,000 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 $3.4
Direct labor $3.4
Variable manufacturing overhead $1.3
Supervisor's salary $2.6
Depreciation of special equipment $1.6
Allocated general overhead $8.5

An outside supplier has offered to make and sell the part to the company for $21.6 each. If this offer is accepted, the supervisor's salary and all of the variable costs 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. If management decides to buy part E07 from the outside supplier rather than to continue making the part, what would be the annual impact on the company's overall net operating income?

Net operating income would decrease by $207,100 per year.
Net operating income would decrease by $6,800 per year.
Net operating income would increase by $207,100 per year.
Net operating income would increase by $6,800 per year.

Solution Preview

The avoidable cost of making the part is
Direct material 3.4
Direct labor ...

Solution Summary

The solution explains how to calculate the impact on the net operating income of a make or buy decision

$2.19