Hey guys,
I am stuck on this question in NINJA
A company is considering outsourcing one of the component parts for its product. The company currently makes 10,000 parts per month. Current costs are as follows:
Per Unit Total
Direct materials $4 $40,000
Direct labor 3 30,000
Fixed plant facility cost 2 20,000
The company decides to purchase the part for $8 per unit from another supplier and rents its idle capacity for $5,000/month. How will the company's monthly income before taxes change?
Incorrect A.
Decrease $15,000
B.
Decrease $10,000
C.
Increase $5,000
D.
Increase $10,000
The answer is C because: The product should be produced if the incremental cost to produce the product, including any opportunity cost of idle facilities, is less than the purchase price.
Since the fixed plant charge will not change due to this decision, it is irrelevant and should not be considered. The direct materials and direct labor costs ($40,000 + $30,000 = $70,000) are relevant costs. These incremental costs total $70,000 per month to make the product, while they can buy the part for $80,000 per month, an increase in monthly costs of $10,000.
However, the rental income from renting the idle capacity of $5,000 reduces the monthly cost of purchasing the parts, for a net increase in monthly income before taxes of $5,000.
My question is, wouldn't it be an overall DECREASE in monthly income of 5,000 since it is more expensive to buy it? I am confused…
FAR: 79
AUD: 81
REG:5/29/15
BEC:85
Using CPA Excel, NINJA notes and audio, NINJA MCQs
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