Ring Company makes telephones. Currently, Ring makes all components of the telephones in-house. An outside company has offered to supply one component, part number X76, for $12 each. Ring uses 22,000 of these components per year. Costs of X76 are as follows: Direct materials $3.00 Direct labor $1.50 Variable overhead $2.75 Fixed overhead $5.00 Suppose that 30% of the fixed overhead is avoidable if part X76 is not made by Ring. Should Ring purchase the part from the outside supplier? a.Yes, income will increase by $10,500. b.Yes, income will increase by $74,500. c.No, income will decrease by $15,000. d.No, income will decrease by $71,500.

An outside company has offered to supply one component, part number X76, for $12 each. Ring uses 22,000 of these components per year. Costs of X76 are as follows: Direct materials $3.00 Direct labor $1.50 Variable overhead $2.75 Fixed overhead $5.00 Suppose that 30% of the fixed overhead is avoidable if part X76 is not made by Ring.

Buy= 12*22,000= 264,000

Fixed overhead= (5*0.70)*22,000= 77,000

Total= $341,000

Make in-house:

Direct material= 3

Direct labor $1.50

Variable overhead $2.75

Fixed overhead $5.00

Total unitary cost= 12.25

Total cost= 12.25*22,000= $269,500

dubeyshailja64 dubeyshailja64 · Answer 2 · 2022-02-16T07:13:51+01:00

The income will decrease by $71,500 if Ring Company chooses to purchase the part rather that in-house production.

What is Decision making and what are the factors that should be considered in decision making?

In business, decision making refers to the process initiated by the management to determine the best course of action to fulfill the requirements.

The factors that need to be considered in decision-making are the cost, risk and rewards, certainty and uncertainty, and so on.

For taking the decision regarding in-house production or purchase of the part, Ring Company should calculate the cost involved in both the options.

Cost of purchase:

[tex]\begin{aligned} \rm Cost \:of \:Purchase &=\rm Purchase\:price + Fixed\:overhead \\\\&= (22,000\:\rm x\:\$12) + (\$5\:x\:70\%)22,000\\\\&= \$264,000 + \$77,000\\\\&= \$341,000\end[/tex]

The fixed overhead are reduced by 30% when the part is not produced by the company. Therefore the fixed overhead will be 70% of $5.

Cost of in-house production:

[tex]\begin{aligned} \rm Direct \:material\:cost (22,000 \:x\: \$3) &= \$66,000\\\\\rm Direct \:labor\:cost (22,000 \:x\: \$1.5) &= \$33,000\\\\\rm Variable\:overhead (22,000\:x\:\$ 2.75) &= \$60,500\\\\\rm Fixed \:overhead (22,000 \:x\: \$5) &= \$110,000\\\end[/tex]

Therefore,

[tex]\rm Total\:cost\:of\:production = \$66,000 + \$33,000 + \$60,500 +\$110,000\\\\\rm Total\:cost\:of\:production = \$269,500[/tex]

The increase in cost will decrease the profits of the company. The increase in cost due to purchase is:

[tex]\rm Increase\:in\:cost = \$341,000 - \$269,500\\\\\rm Increase\:in\:cost = \$71,500[/tex]

The profits therefore will decrease by $71,500 if the company chooses to purchase the part.

Hence the correct option is D.

Learn more about decision making here:

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