Question

The O.T. Company makes 35,000 motors to be used in the production of its sewing machines. The cost per motor at this level of activity is:

Direct materials: $4.50

Direct labor: $4.60

Variable manufacturing overhead: $3.75

Fixed manufacturing overhead: $3.45

An outside supplier has offered to supply all the motors the company needs for $15 each.

If O.T. Company decided not to make the motors, there would be no other use for the production facilities and none of the fixed manufacturing overhead cost could be avoided.

If O.T. Company decides to continue making the motor, how much higher or lower would net operating income be than if the motors are purchased from the outside supplier?

a. $75,250 higher

b. $45,500 lower

c. $311,500 higher

d. $120,750 higher

Answer 1

If O.T. Company continues to make the motors instead of purchasing them, their net operating income would be $45,500 lower. The total cost of production is higher than the cost to purchase the motors.

Step-by-step explanation:

If O.T. Company decides to continue making the motor, we should compare the costs of making vs buying the motors. The cost to make one motor is the sum of direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead costs, which is $4.50 + $4.60 + $3.75 + $3.45 = $16.30 per motor. When producing 35,000 motors, the total cost to make them would be 35,000 motors × $16.30/motor = $570,500. On the other hand, if the motors are purchased from the outside supplier at $15 each, the total cost would be 35,000 motors × $15/motor = $525,000.

Comparing the two totals, if the company continues to make the motors, the net operating income would be:
$570,500 (making) - $525,000 (buying) = $45,500 higher when buying from the supplier.

Thus, the net operating income would be $45,500 lower if O.T. Company decides to continue making the motors.