Derby Inc. manufactures a product which contains a small part. The company has a

Question

Derby Inc. manufactures a product which contains a small part. The company has always purchased this motor from a supplier for $125 each. Derby recently upgraded its own manufacturing capabilities and now has enough excess capacity (including trained workers) to begin manufacturing the motor instead of buying it. The company prepared the following per unit cost projections of making the motor, assuming that overhead is allocated to the part at the normal predetermined overhead rate of 150% of direct labor cost.

The required volume of output to produce the motors will not require any incremental fixed overhead. Incremental variable overhead cost is $21 per motor. What is the effect on income if Derby decides to make the motors?

Income will decrease by $16 per unit. Income will increase by $16 per unit. Income will increase by $23 per unit. Income will decrease by $23 per unit. Income will increase by $39 per unit.

Explanation / Answer

New setup: Overhead = $21/ unit.. Hence per unit total cost = 38+50+21 = $109 Cost of outsourcing = $ 125 Hence, Income increases by $ (125-109) = $ 16 per unit (2nd choice is correct)

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