Another Mind Bender

[craig]

Foster Industries manufactures 20,000 components per year. The manufacturing cost of the components was determined as follows:

Direct materials $150,000
Direct labor 240,000
Variable manufacturing overhead 90,000
Fixed manufacturing overhead 120,000
Total $600,000

An outside supplier has offered to sell the component for $25.50.

Foster Industries can rent its unused manufacturing facilities for $45,000 if it purchases the component from the outside supplier.

What is the effect on income if Foster purchases the component from the outside supplier?

a. $45,000 increase
b. $15,000 increase (I say the answer is $15,000 increase)
c. $75,000 decrease
d. $105,000 increase

My reasoning:

To Make is $480,000 (Direct Mat + Labor + Var OH)

To Buy is $465,000 ($25.50 - $2.25 = $23.25 per unit. times 20,000 units = $465,000)

Am I on the right track?

 

[Ronika]

Sounds like you are on the right track, Craig.
He will have to incur $120k of fixed manufacturing overhead regardless of whether he makes or buys. However, if he buys, he will be able to reduce this by $45k.

 

[sshelly0525]

Yes, this is the correct answer.

 

[M Zaid]

Yes, this is the correct answer.

yes this is correct