Composite Company uses 5,000 units of part AA1 each year. The cost of manufacturing one unit of part AA1 at this volume is as follows: An outside supplier has offered to sell Composite Company unlimited quantities of part AA1 at a unit cost of $32.00. If Composite Company accepts this offer, it can eliminate 50 percent of the fixed costs assigned to part AA1. Furthermore, the space devoted to the manufacture of part AA1 would be rented to another company for $24,000 per year. If Composite Company accepts the offer of the outside supplier, annual profits will
A) increase by $17,000.
B) increase by $24,000.
C) increase by $34,000.
D) increase by $3,500.

Question

Composite Company uses 5,000 units of part AA1 each year. The cost of manufacturing one unit of part AA1 at this volume is as follows:  An outside supplier has offered to sell Composite Company unlimited quantities of part AA1 at a unit cost of $32.00. If Composite Company accepts this offer, it can eliminate 50 percent of the fixed costs assigned to part AA1. Furthermore, the space devoted to the manufacture of part AA1 would be rented to another company for $24,000 per year. If Composite Company accepts the offer of the outside supplier, annual profits will
A) increase by $17,000. 
B) increase by $24,000. 
C) increase by $34,000. 
D) increase by $3,500.

Quizplus · Accepted Answer

Currently, Composite Company is spending $23 per unit on manufacturing part AA1 (as indicated in the cost breakdown image). The new proposed supplier is offering a unit cost of $32. By accepting the offer, the company can eliminate 50% of the fixed costs assigned to part AA1, which amounts to $11,000 ($22,000 * 50%). Additionally, if they choose to rent the space devoted to part AA1 manufacturing, they will receive $24,000 per year.

The new cost of purchasing 5,000 units from the supplier would be $160,000 ($32 * 5,000). Therefore, the total cost savings per year would be:

Cost savings on fixed costs: $11,000
Cost savings on manufacturing costs: $60,000 (5000 units x $12)
Rent received for the space: $24,000

Total cost savings: $95,000

As a result of these savings, the company's profits will increase by $34,000 ($95,000 - $61,000). Therefore, the best choice is C: annual profits increase by $34,000 if Composite Company accepts the outside supplier's offer.

Composite Company Uses 5,000 Units of Part AA1 Each Year