Complete question:
Rama Corporation is presently making part J56 that is used in one of its products. A total of 4,000 units of this part are produced and used every year. The company's Accounting Department reports the following costs of producing the part at this level of activity:
Direct materials____ $1.80 per unit
Direct labour_______$7.80 per unit
Variable overhead__ $7.90 per unit
Supervisor's salary__$2.30 per unit
Depreciation of special equipment________$6.90 per unit
Allocated general overhead_________$6.60 per unit
An outside supplier has offered to produce and sell the part to the company for $30.80 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company, none of which would be avoided if the part were purchased instead of produced internally. In addition to the facts given above, assume that the space used to produce part J56 could be used to make more of one of the company's other products, generating an additional segment margin of $13,000 per year for that product.
What would be the impact on the company's overall net operating income of buying part J56 from the outside supplier and using the freed space to make more of the other product
Answer:
The company's net operating income will decline by $31,000 per year, if they buy part J56 from the outside supplier, despite using the freed space to make more of other product.
Explanation:
Given:
Total produced a year = 4000 units
Relevant cost if Rama corporation produces the part internally =
(Direct material) $1.80 + (Direct labour) $7.8 + (Variable overhead) $7.90 + (Supervisor's salary) $2.30 = $ 19.80 per unit.
The total cost of production will be=
$19.80 * 4000
= $79,200
If they buy from the external supplier, the total cost would be=
$30.80 * 4000
= $123,200
Since they would generate $13,000 producing another product using the freed space. The net cost of buying from the supplier will be:
$123,200 - $13,000
= $110,200
The company will make a loss of $31,000 ($79,200 - $110,200) if they buy part J56 from the outside supplier, despite using the freed space to make more of other product.
