New England Retrofitting Inc. (NERI)has been making a six point wiggle used in o
ID: 2453775 • Letter: N
Question
New England Retrofitting Inc. (NERI)has been making a six point wiggle used in one of its products for the last ten years. Equipment and manufacturing space has been operating efficiently and a new lease was recently signed for another 3 years. The cost breakdown for each six point wiggle is as follows: Direct Materials ............$14.50 Direct Labor..................$12.00 Variable Manufacturing Overhead $7.50 Fixed Manufacturing Overhead $120,000 annually or $12.00 per wiggle (based on 100,000 wiggles production). Total Cost of Wiggle Production per year $4,600,000 or $46.00 per wiggle. The Shake and Bake Company (SBC) has approached NERI with a proposal to provide the same wiggle that it makes at a price of $39.00 each with guaranteed delivery of 100,000 wiggle annually. What would be the net effect on Net Operating income if the offer from SBC was accepted? (5 points with shown computation). Based on this result, would you continue to make the wiggle or buy it from SBC? (5 points)
Explanation / Answer
Saving in the cost if is offered at $39.
Savings = $46-$39 = $7 per Wriggle
Unavoidable fixed cost if the production is Stopped is $12.
Thus, the net loss if the offer is accepted is $12-$7 = $5*100,000 = $500,000.
Therefore, the offer should not be accepted.
Variable costs can be avoided but allocated fixed cost should be incurred irrespective of production.