Derby Inc. manufactures a product which contains a small part. The company has always purchased this motor from a supplier for $125 each. Derby recently upgraded its own manufacturing capabilities and now has enough excess capacity (including trained workers) to begin manufacturing the motor instead of buying it. The company prepared the following per unit cost projections of making the motor, assuming that overhead is allocated to the part at the normal predetermined overhead rate of 150% of direct labor cost.
$\begin{array}{lr}
\text { Direct materials } & \$ 38 \
\text { Direct labor } & 50 \
\text { Overhead (fixed and } & 75 \
\text { variable) } & \
\text { Total } & \$ 163
\end{array}$
The required volume of output to produce the motors will not require any incremental fixed overhead. Incremental variable overhead cost is $21 per motor. What is the effect on income if Derby decides to make the motors?

Question

Derby Inc. manufactures a product which contains a small part. The company has always purchased this motor from a supplier for $125 each. Derby recently upgraded its own manufacturing capabilities and now has enough excess capacity (including trained workers) to begin manufacturing the motor instead of buying it. The company prepared the following per unit cost projections of making the motor, assuming that overhead is allocated to the part at the normal predetermined overhead rate of 150% of direct labor cost. 
$\begin{array}{lr}
\text { Direct materials } & \$ 38 \
\text { Direct labor } & 50 \
\text { Overhead (fixed and } & 75 \
\text { variable) } & \
\text { Total } & \$ 163
\end{array}$ 
The required volume of output to produce the motors will not require any incremental fixed overhead. Incremental variable overhead cost is $21 per motor. What is the effect on income if Derby decides to make the motors?

Quizplus · Accepted Answer

The company can save $125 - $163 = $38 per unit by making the motors instead of buying them. However, the company will incur an incremental variable overhead cost of $21 per motor. Therefore, the net effect on income is an increase of $38 - $21 = $16 per unit.

Derby Inc Manufactures a Product Which Contains a Small Part