How much will profit change if the outside offer is accepted

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Reference no: EM132899470

Make or Buy Review

Ace Company makes 50,000 units of Part 86A each year. At this level of activity, the cost per unit for Part 86A is:

Direct Materials $6.00

Direct Labour 8.00

Variable mfg overhead 3.00

Fixed mfg overhead 9.00

Total Cost per Part $26.00

An outside supplier has offered to sell 50,000 units of Part 86A each year to Ace for $22.00 per part. If Ace accepts the offer, the facilities currently used to make Part 86A can be rented out to another company for $100,000 per year.

Ace has calculated that $4 of the fixed manufacturing overhead being applied per unit to Part 86A would continue even if the part is purchased from the outside supplier.

REQUIRED: How much will profit change if the outside offer is accepted.

Drop Company

By Division ('000s)

Q R S Total

Sales 5,000 6,000 6,000 17,000

Variable Costs 2,000 3,000 3,500 8,500

C.M. 3,000 3,000 2,500 8,500

Fixed Cost 1,000 1,500 2,600 5,100

Operating Income 2,000 1,500 (100) 3,400

The company allocates Fixed Cost by floor space and by sales. The company decides to drop losing Division S to make more money.

Much of the fixed cost is plant insurance, amortization, equipment repairs, taxes, landscaping and will not be lost when Division S closes.

The only savings are that employees costing $280,000 will be let go. Termination costs total $50,000. Other Fixed expenses costing $200,000 will be stopped. Division Q will increase Sales $200,000 as spill over sales, while Division R will lose $400,000 sales because of lost customers from the closure of Division S.

How much will Operating Income change if Division S closes?

Reference no: EM132899470

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