Cotton Corp. currently makes 10,000 subcomponents a year in one of its factories. The unit costs to produce are: An outside supplier has offered to provide Cotton Corp with the 10,000 subcomponents at a $84.50 per unit price. Fixed overhead is not avoidable. If Cotton Corp accepts the outside offer, what will be the effect on short-term profits?
A) $260,000 increase
B) $195,000 decrease
C) no change
D) $65,000 increase

Question

Cotton Corp. currently makes 10,000 subcomponents a year in one of its factories. The unit costs to produce are:  An outside supplier has offered to provide Cotton Corp with the 10,000 subcomponents at a $84.50 per unit price. Fixed overhead is not avoidable. If Cotton Corp accepts the outside offer, what will be the effect on short-term profits?
A) $260,000 increase 
B) $195,000 decrease 
C) no change 
D) $65,000 increase

Quizplus · Accepted Answer

Currently, the cost for Cotton Corp to produce 10,000 subcomponents is: 
10,000 x $42.25 (unit cost) = $422,500

If they accept the outside supplier's offer of $84.50 per unit: 
10,000 x $84.50 = $845,000

Therefore, if they accept the offer, their costs would increase by $422,500. As fixed overhead is not avoidable, the effect on short-term profits would be a decrease of $195,000 (difference between current costs and costs with the outside offer): 
$422,500 - $845,000 = -$422,500 
-$422,500 + $195,000 = -$227,500 
Thus, the answer is choice B, a $195,000 decrease in short-term profits.