The O.T. Company makes 35,000 motors to be used in the production of its sewing machines. The cost per motor at this level of activity is:Direct materials$\quad$$\quad$$£ 4.50$
Direct labour$\quad$$\quad$$£ 4.60$
Variable manufacturing overhead.$\quad$$£ 3.75$
Fixed manufac turing ov erhead.$\quad$$£ 3.45$
An outside supplier has offered to supply all the motors the company needs for £15 each. If O.T. Company decided not to make the motors, there would be no other use for the production facilities and none of the fixed manufacturing overhead cost could be avoided. If O.T. Company decides to continue making the motor, how much higher or lower would net operating income be than if the motors are purchased from the outside supplier

A)£75,250 higher.
B)£45,500 lower.
C)£311,500 higher.
D)£120,750 higher.

Question

The O.T. Company makes 35,000 motors to be used in the production of its sewing machines. The cost per motor at this level of activity is:Direct materials$\quad$$\quad$$£ 4.50$
Direct labour$\quad$$\quad$$£ 4.60$
Variable manufacturing overhead.$\quad$$£ 3.75$
Fixed manufac turing ov erhead.$\quad$$£ 3.45$
An outside supplier has offered to supply all the motors the company needs for £15 each. If O.T. Company decided not to make the motors, there would be no other use for the production facilities and none of the fixed manufacturing overhead cost could be avoided. If O.T. Company decides to continue making the motor, how much higher or lower would net operating income be than if the motors are purchased from the outside supplier

A)£75,250 higher.
B)£45,500 lower.
C)£311,500 higher.
D)£120,750 higher.

Quizplus · Accepted Answer

The cost to make one motor is £4.50 (direct materials) + £4.60 (direct labour) + £3.75 (variable manufacturing overhead) + £3.45 (fixed manufacturing overhead) = £16.30. The cost to buy one motor is £15. Therefore, making a motor is £1.30 more expensive per unit than buying. For 35,000 motors, the difference is 35,000 * £1.30 = £45,500. However, since the fixed manufacturing overhead of £3.45 per unit cannot be avoided even if the motors are purchased externally, the relevant comparison should exclude this cost. Thus, the cost to make a motor excluding fixed overhead is £12.85 (£16.30 - £3.45), making it cheaper to produce the motor in-house by £2.15 (£15 - £12.85) per unit. For 35,000 motors, this results in a net operating income that is £75,250 higher (£2.15 * 35,000) than purchasing the motors.

The OT Company Makes 35,000 Motors to Be Used in the the Production