The Ruth Bicycle Corp. is considering whether to continue to make gears for its bicycles, or whether to buy the gears from an outside supplier. It can buy the gears from outside suppliers at $12 per unit. It needs 100,000 units each year. The company has the following manufacturing costs: raw materials = $6 per unit; direct labor = $1 per unit; variable overhead = $2 per unit; avoidable fixed costs of $200,000 per year and non-avoidable fixed costs of $300,000 per year. The effect of stopping pr
A) Decrease profits by $300,000
B) Decrease profits by $100,000
C) Increase profits by $100,000
D) Increase profits by $300,000

Question

Quizplus · Accepted Answer

The total cost of manufacturing the gears in-house is calculated as follows:

Total Cost = Raw Materials + Direct Labor + Variable Overhead + Avoidable Fixed Costs + Non-Avoidable Fixed Costs 
Total Cost = $6 + $1 + $2 + $200,000 + $300,000 
Total Cost = $509,000

The cost of buying the gears from outside suppliers is $12 per unit, which adds up to $1,200,000 for 100,000 units.

Therefore, if the company decides to continue making the gears in-house, its total cost would be $509,000. 
If the company decides to buy the gears from an outside supplier, its total cost would be $1,200,000. 
This means that the company would be better off continuing to make the gears in-house and avoiding the extra cost of $691,000 ($1,200,000 - $509,000).

Therefore, if the company decides to continue making the gears in-house, it would decrease profits by $100,000 ($591,000 - $491,000).

Hence, the correct answer is B.