Ortega Industries manufactures 15,000 components per year. The manufacturing cost of the components was determined to be as follows:
$$\begin{array} { l r }
\text { Direct materials } & \$ 150,000 \
\text { Direct labor } & 240,000 \
\text { Variable maruffacturing overhead } & 90,000 \
\text { Fixed marnufacturing overhead } & \underline{120,000} \
\text { Total } & \underline{\$ 600,000} \

\end{array}$$
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Assume that the fixed manufacturing overhead reflects the cost of Ortega's manufacturing facility. This facility cannot be used for any other purpose. An outside supplier has offered to sell the component to Ortega for $34. If Ortega Industries purchases the component from the outside supplier, the effect on operating profits would be a:
A) $30,000 decrease.
B) $30,000 increase.
C) $90,000 decrease.
D) $90,000 increase.

Question

Ortega Industries manufactures 15,000 components per year. The manufacturing cost of the components was determined to be as follows:
$$\begin{array} { l r } 
\text { Direct materials } & \$ 150,000 \
\text { Direct labor } & 240,000 \
\text { Variable maruffacturing overhead } & 90,000 \
\text { Fixed marnufacturing overhead } & \underline{120,000} \
\text { Total } & \underline{\$ 600,000} \

\end{array}$$
-
Assume that the fixed manufacturing overhead reflects the cost of Ortega's manufacturing facility. This facility cannot be used for any other purpose. An outside supplier has offered to sell the component to Ortega for $34. If Ortega Industries purchases the component from the outside supplier, the effect on operating profits would be a:
A) $30,000 decrease.
B) $30,000 increase.
C) $90,000 decrease.
D) $90,000 increase.

Quizplus · Accepted Answer

If Ortega purchases the components, they will save on direct materials, direct labor, and variable manufacturing overhead, totaling $480,000. However, they will incur a cost of $510,000 (15,000 components x $34) from the supplier. The fixed manufacturing overhead of $120,000 is a sunk cost and irrelevant to the decision. Therefore, the operating profit will decrease by $30,000 ($510,000 - $480,000).

Ortega Industries Manufactures 15,000 Components Per Year - Assume That the Fixed Manufacturing Overhead Reflects the Cost

Ortega Industries Manufactures 15,000 Components Per Year -
Assume That the Fixed Manufacturing Overhead Reflects the Cost