Question

The Talbot Corporation makes wheels that it uses in the production of bicycles. Talbot's costs to produce 180,000 wheels annually are:

Direct materials $36,000
Direct labor $54,000
Variable manufacturing overhead $27,000
Fixed manufacturing overhead $66,000

An outside supplier has offered to sell Talbot similar wheels for $0.80 per wheel. If the wheels are purchased from the outside supplier, $21,000 of annual fixed overhead could be avoided and the facilities now being used could be rented to another company for $51,000 per year. Direct labor is a variable cost. If Talbot chooses to buy the wheel from the outside supplier, then annual net operating income would: __________

Answer 1

If the company chooses to buy the wheels, income will increase by $69,000.

Step-by-step explanation:

First, we need to calculate the total relevant cost of production:

Relevant cost of production:

Total cost= direct material + direct labor + avoidable overhead

Total cost= 36,000 + 54,000 + (27,000 + 45,000)

Total cost= $162,000

Now, the total cost of buying the wheels:

Total cost= 180,000*0.8 - 51,000= $93,000

Difference= 93,000 - 162,000= -$69,000

If the company chooses to buy the wheels, income will increase by $69,000.