Frank Industries manufactures 200,000 components per year. The manufacturing cost of the components was determined as follows: Direct materials$200,000 Direct labor 320,000 Variable manufacturing overhead 120,000 Fixed manufacturing overhead 160,000 An outside supplier has offered to sell the component for $3.40 each. If Frank purchases the component from the outside supplier, the manufacturing facilities would be unused and could be rented out for $20,000.Required:a. If Frank purchases the component from the supplier instead of manufacturing it, the effect on income would be:b. What is the maximum price Frank would be willing to pay the outside supplier?

Question

What will be an ideal response?

Answer 1

a.
Make: $640,000*; Buy: 200,000 × $3.40 = $680,000 ? $20,000 = $660,000; income effect: $640,000 ? $660,000 = $20,000 decrease in income if units are purchased.

b.
($640,000* + 20,000)/200,000 = $3.30.

*Variable cost to make = $200,000 + 320,000 + 120,000 = $640,000.