Baron Company incurs the following annual costs in producing 25,000 ignition swi

Question

Baron Company incurs the following annual costs in producing 25,000 ignition switches for motor scooters: Direct materials $50,000 Direct labor 75,000 Variable manufacturing overhead 40,000 Fixed manufacturing overhead 60,000 Total manufacturing costs $225,000 Total cost per unit ($225,000/25,000 units) $9 Alternatively, Baron Company may purchase the ignition switches from Ignition, Inc. at a price of $8 per unit. Assume that only $10,000 of Baron’s fixed manufacturing overhead will be eliminated if Baron chooses to purchase the units from Ignition, Inc. Question-What will be the effect on Baron’s net operating income if it decides to purchase the units from Ignition, Inc. rather than make them internally? Specify whether net operating income will increase or decrease or not change (if increase or decrease, specify the amount of increase or decrease).

Explanation / Answer

Make       Buy     Net Income Increase (Decrease) Direct materials $ 50,000 $     - 0 - $ 50,000           Direct labor 75,000 - 0 - 75,000 Variable manufacturing costs 40,000 - 0 - 40,000 Fixed manufacturing costs 60,000 50,000 10,000 Purchase price 25000*8          -0-   2,00,000 -2,00,000 Total annual cost $225,000 $250,000 $ (25,000)

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