Answer the following questions using the information below:
Donald's Engine Company manufactures part TE456 used in several of its engine models. Monthly production costs for 1,000 units are as follows:
It is estimated that 10% of the fixed overhead costs assigned to TE456 will no longer be incurred if the company purchases TE456 from the outside supplier. Donald's Engine Company has the option of purchasing the part from an outside supplier at $42.50 per unit.
-If Donald's Engine Company purchases 1,000 TE456 parts from the outside supplier per month, then its monthly operating income will:
A)increase by $1,000
B)increase by $40,000
C)decrease by $1,500
D)decrease by $42,500

Question

Answer the following questions using the information below:
Donald's Engine Company manufactures part TE456 used in several of its engine models. Monthly production costs for 1,000 units are as follows:
  It is estimated that 10% of the fixed overhead costs assigned to TE456 will no longer be incurred if the company purchases TE456 from the outside supplier. Donald's Engine Company has the option of purchasing the part from an outside supplier at $42.50 per unit.
-If Donald's Engine Company purchases 1,000 TE456 parts from the outside supplier per month, then its monthly operating income will:
A)increase by $1,000 
B)increase by $40,000 
C)decrease by $1,500 
D)decrease by $42,500

Quizplus · Accepted Answer

The monthly production cost per unit for manufacturing TE456 part is $77.50 (fixed cost of $46,000 + variable cost of $31.50). If the company purchases TE456 from an outside supplier at $42.50 per unit, it saves $35 per unit. 
The total cost saved per month by purchasing 1,000 units from the outside supplier would be $35,000 (1,000 x $35). 
However, it is given that 10% of the fixed overhead costs assigned to TE456 will no longer be incurred if the company purchases TE456 from the outside supplier. The fixed cost saved per month would be $4,600 (10% of $46,000). 
Therefore, the net cost saved per month would be $30,400 ($35,000 - $4,600). This means the monthly operating income will decrease by $1,500 ($30,400 - $31,900, the cost of producing 1,000 units in-house). Therefore, the best choice is C.

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