Vest Industries manufactures 40,000 components per year. The manufacturing cost of the components was determined as follows: $\begin{array}{lr}
\text { Direct materials } & \$ 5,000 \
\text { Direct labor } & 120,000 \
\text { Variable overhead } & 45,000 \
\text { Fixed overhead } & 60,000 \
\text { Total } & \$ 300,000
\end{array}$ An outside supplier has offered to sell the component for $12.75. Fixed cost will remain the same if the component is purchased from an outside supplier.
Vest Industries can rent its unused manufacturing facilities for $45,000 if it purchases the component from the outside supplier.
What is the effect on income if Vest purchases the component from the outside supplier?
A) $225,000 decrease
B) $195,000 increase
C) $165,000 decrease
D) $135,000 increase

Question

Quizplus · Accepted Answer

If Vest purchases the component from the outside supplier, it will save the following costs:Direct materials: $5,000Direct labor: $120,000Variable overhead: $45,000Total savings: $170,000However, Vest will also lose the revenue from selling the components, which is $40,000 x $12.75 = $510,000.Therefore, the net effect on income is a decrease of $510,000 - $170,000 = $340,000.However, Vest will also save the fixed costs of $60,000, which will reduce the decrease in income to $340,000 - $60,000 = $280,000.Finally, Vest will earn $45,000 from renting its unused manufacturing facilities, which will further reduce the decrease in income to $280,000 - $45,000 = $235,000.Therefore, the correct answer is A) $225,000 decrease.

Vest Industries Manufactures 40,000 Components Per Year An Outside Supplier Has Offered to Sell the Component for of the Components