Part P40 is a part used in the production of air conditioners at Jackson Corporation. The following costs and data relate to the production of Part P40: Jackson Corporation can purchase the part from an outside supplier for $4.67 per unit. If they purchase from the outside supplier, 50% of the fixed costs would be avoided. Assume that factory space freed up by purchasing the part from an outside source can be used to manufacture another product that can be sold for $2500 profit. If Jackson Corporation makes the part, what will its operating income be?
A)$12,410 less than if the company bought the part
B)$12,410 greater than if the company bought the part
C)$17,410 greater than if the company bought the part
D)$126,410 greater than if the company bought the part

Question

Part P40 is a part used in the production of air conditioners at Jackson Corporation. The following costs and data relate to the production of Part P40:  Jackson Corporation can purchase the part from an outside supplier for $4.67 per unit. If they purchase from the outside supplier, 50% of the fixed costs would be avoided. Assume that factory space freed up by purchasing the part from an outside source can be used to manufacture another product that can be sold for $2500 profit. If Jackson Corporation makes the part, what will its operating income be?
A)$12,410 less than if the company bought the part 
B)$12,410 greater than if the company bought the part 
C)$17,410 greater than if the company bought the part 
D)$126,410 greater than if the company bought the part

Quizplus · Accepted Answer

Let's calculate the operating income if Jackson Corporation makes the part:

Total cost per unit = Direct materials + Direct labor + Variable overhead + Fixed overhead/Number of units produced
Total cost per unit = $5.70 + $2.50 + $2.90 + $0.60 = $11.70/unit

Operating Income = Selling Price – Total Cost per Unit x Number of Units
Operating Income = $20.00/unit – $11.70/unit x 10,000 units = $83,000

If Jackson Corporation buys the part instead, they would pay $4.67/unit, which means they would save $6.03/unit in total costs because they would avoid 50% of the fixed overhead. This would make their total cost per unit $5.67.

Operating Income = Selling Price – Total Cost per Unit x Number of Units
Operating Income = $20.00/unit – $5.67/unit x 10,000 units = $143,000

Since $143,000 is $12,410 greater than $83,000, the correct answer is B) $12,410 greater than if the company bought the part.

Part P40 Is a Part Used in the Production of Air