Question

Ethridge corp is presently making part A that is used in one of its products. A total of 9000 units of this part are used every year. The comps acc dept reports the following costs of producing part A at this level of activity: DM.............$1.90/unit DL.............$7.70/unit VMOH......$1.20/unit Supervisor Salary.........$1.90/unit Depreciation of special equipment........$2.90/unit Allocated general overhead.......$6.30/unit An outside supplier has offered to make and sell the part to the company for $15.40 each. If the offer is accepted, the supervisors salary and all of Vcosts can be avoided. The special equipment used to make the part was purchaseed many tears ago and has no salvage value or other use. The allocated general overhead represents Fcosts of the entire comp, none of twhich would be avoided if part A were purchased instead of made. If management decides to buy part A from the supplier rather than make it, what would be the annual impact on the comapanys overall NOI??

1) NOI inc by $24,300/year
2) NOI would Dec by $24,300/year
3) NOI would inc by $58,500/year
4) NOI would dec by $58,500/year

Answer 1

The Correct option is 3). If Ethridge Corp decides to purchase part A, their NOI would increase by $58,500 per year, as they save $6.50 per unit on the 9000 units used annually, considering only the relevant avoidable costs.

Step-by-step explanation:

The student's question pertains to a make-or-buy decision for Ethridge Corp concerning part A used in one of its products. To determine the annual impact on the company's overall net operating income (NOI) if the part is purchased instead of made, we must calculate the change in total costs. The costs associated with producing the part internally include direct materials (DM), direct labor (DL), variable manufacturing overhead (VMOH), the supervisor's salary (which can be avoided if the part is purchased), depreciation of special equipment (assumed to be a sunk cost), and allocated general overhead (which would remain unchanged).

Current cost to produce one unit internally = $1.90 + $7.70 + $1.20 + $1.90 + $2.90 + $6.30 = $21.90/unit
Cost if part is purchased = $15.40/unit
Cost difference per unit = $21.90 - $15.40 = $6.50/unit saved
Annual cost difference = $6.50/unit × 9000 units = $58,500/year saved
Since the supervisor's salary and variable costs are avoidable, and the special equipment's depreciation and allocated general overhead are non-avoidable/sunk costs, the relevant costs lead to potential savings. Therefore, if the company purchases part A instead of producing it, its NOI would increase by $58,500 per year. The allocated general overhead is not considered because it won't change whether the part is made or bought.