CM manufacturing has provided the following unit costs pertaining to a component

ID: 2477094 • Letter: C

Question

CM manufacturing has provided the following unit costs pertaining to a component they manufacture and use in the production of one of their main products. A supplier has offered to provide the component to CM manufacturing for $630 per unit. If CM Manufacturing acquire the component from the supplier, they could use the released facilities to manufacture a product which would generate contribution margin of $20,000 annually. Assuming that CM Manufacturing needs 3,000 components annually and the fixed manufacturing overhead is unavoidable, what would be the impact on operating income if the company outsources? Operating income would go down by $10,000. Operating income would go up by $20,000. Operating income would go down by $18,000. Operating income would go up by $26,000.

Explanation / Answer

Cost of Manufacturing inside

Variable Costs:

Amount

Direct materials

$ 420

Direct labor

$ 110

Variable manufacturing costs

$ 90

Total Manufacturing Cost

$ 620

Cost of Buying from outside supplier $630 per unit

Less: Cost of Manufacturing Inside $620 per unit

--------------------

Incremental cost of buying form outside supplier $10 per unit

No of units expected to Purchase =3,000 units

Total Incremental cost of buying form outside supplier = 3,000 x $10 = $30,000

Less : Rental Income $20,000

----------------

Decrease in operating Income $10,000

Fixed Cost is sunk cost and hence irrelevant for decision making.

Option 1 is correct