Question

The Rodgers Company makes 27,000 units of a certain component each year for use in one of its products. The cost per unit for the component at this level of activity is as follows:

Direct Materials $4.20
Direct Labour $12
Variable Manufacturing Overhead $5.80
Fixed Manufacturing Overhead $6.50

Rodgers has received an offer from an outside supplier that is willing to provide 27,000 units of this component each year at a price of $25 per component. Assume that direct labour is a variable cost.
Assume that if the components were to be purchased from the outside supplier, $35,100 of annual fixed manufacturing overhead would be avoided, and the facilities now being used to make the component would be rented to another company for $64,800 per year. If Rodgers chooses to buy the component from the outside supplier under these circumstances, what would be the impact on annual operating income due to accepting the offer?

Answer 1

If Rodgers chooses to buy the component from the outside supplier, the annual operating income would increase by $94,500.

Step-by-step explanation:

To determine the impact on annual operating income if Rodgers chooses to buy the component from the outside supplier, we need to compare the costs of producing the component in-house with the cost of purchasing it from the supplier.

Currently, the cost per unit for the component is $4.20 for direct materials, $12 for direct labor, $5.80 for variable manufacturing overhead, and $6.50 for fixed manufacturing overhead. This results in a total cost per unit of $28.50. Multiplying this by the number of units (27,000) gives a total cost of $769,500.

If Rodgers were to accept the offer from the outside supplier, the cost per unit would be $25. Multiplying this by the number of units (27,000) gives a total cost of $675,000.

If Rodgers chooses to buy the component from the outside supplier, the annual operating income would increase by:

$769,500 - $675,000 = $94,500