Question

The Talbot Corporation makes wheels that it uses in the production of bicycles. Talbot's costs to produce 100,000 wheels annually are: Direct materials $30,000 Direct labor $50,000 Variable manufacturing overhead $20,000 Fixed manufacturing overhead $70,000 An outside supplier has offered to sell Talbot similar wheels for $1.25 per wheel. If the wheels are purchased from the outside supplier, $15,000 of annual fixed overhead could be avoided and the facilities now being used could be rented to another company for $45,000 per year. Direct labor is a variable cost. If Talbot chooses to buy the wheel from the outside supplier, then annual net operatingincome would: A. Increase by $35,000 B. Decrease by $10,000 C. Increase by $45,000 D. Increase by $70,000

Answer 1

Answer:

Increase in net annual operating income  $35,000

Explanation:  

                                                                                                    $

Variable cost of internal production

(30,000+50,000 + 20,000)                                                    100,000

Variable cost of purchase  (1.25× 100,000)                           125,000

Extra variable cost of buying                                                  ( 25,000)

Add savings in fixed cost from                                                15,000

Add rent from facilities                                                            45,000

Increase in net annual operating income                              35,000

Increase in net annual operating income  $35,000

The balance of the the fixed  cost is not relevant hence it was  not considered. This is so because whatever decision is taken, it would be incurred either way