Question

Ajax Company can make a component for its final product but is considering buying the component from an outside supplier. The supplier has offered a price of $10 each, and Ajax requires 20,000 components. Given the following per-unit information to make the product, compute the increase or decrease in profits if Ajax purchases the component. a) $10,000 increase in profits b) $10,000 decrease in profits c) $200,000 increase in profits d) $200,000 decrease in profits

Answer 1

b) $10,000 decrease in profits because Purchasing the component from the supplier for $10 each results in a $10,000 decrease in profits compared to making it in-house.

Step-by-step explanation:

Ajax Company should compare the cost of making the component in-house versus purchasing it from the outside supplier. If the cost of making the component is less than $10, Ajax should produce it internally; otherwise, they should buy it.

Assuming the cost to make the component internally is less than $10, Ajax would incur a higher expense by purchasing it for $10 from the supplier, resulting in a decrease in profits.

To calculate the increase or decrease in profits, subtract the total cost of purchasing the components from the cost of producing them internally and then multiply by the quantity needed. If the difference is negative, it represents a decrease in profits. In this case, if Ajax can produce the component for less than $10, the decrease in profits would be $10,000 ([$10 - Cost to make] * Quantity).

This implies that sticking to in-house production is financially favorable, as buying from the supplier would lead to a reduction in profits by $10,000.

Therefore the coreect option is b) $10,000 decrease.