Question

Derby Inc. manufactures a product which contains a small part. The company has always purchased this motor from a supplier for $125 each. Derby recently upgraded its own manufacturing capabilities and now has enough excess capacity (including trained workers) to begin manufacturing the motor instead of buying it. The company prepared the following per unit cost projections of making the motor, assuming that overhead is allocated to the part at the normal predetermined overhead rate of 150% of direct labor cost.

Direct material $38Direct labor 50Overhead fixed and variable 75
Total 163
The required volume of output to produce the motors will not require any incremental fixed overhead. Incremental variable overhead cost is $21 per motor. What is the effect on income if Derby decides to make the motors?
a. Income will decrease by $16 per unit.
b. Income will increase by $16 per unit.
c. Income will increase by $23 per unit
d. Income will decrease by $23 per unit.
e. Income will increase by $39 per unit.

Answer 1

Derby Inc.

If Derby decides to make the motors,

b. Income will increase by $16 per unit.

Step-by-step explanation:

a) Data and Calculations:

Bought-in cost = $125

Predetermined overhead rate = 150% of direct labor cost

Direct material $38

Direct labor 50

Overhead fixed and variable 75

Total cost per unit $163

Incremental variable overhead cost = $21

Total variable cost = $109 ($38 + 50 + 21)

Differential Income per unit = $16 ($125 - $109)

b) Making the motors in-house will increase income by $16 than buying it outside. This differential income is obtained by comparing the cost of buying the motors from suppliers and the cost of making the motors internally.