Part P40 is a part used in the production of air conditioners at Jackson Corporation. The following costs and data relate to the production of Part P40: Jackson Corporation can purchase the part from an outside supplier for $4.72 per unit. If they purchase from the outside supplier, 50% of the fixed costs would be avoided. If Jackson Corporation makes the part, how much will its operating income be?
A)$71,500 greater than if the company bought the part
B)$22,500 greater than if the company bought the part
C)$26,500 greater than if the company bought the part
D)$140,500 greater than if the company bought the part

Question

Part P40 is a part used in the production of air conditioners at Jackson Corporation. The following costs and data relate to the production of Part P40:  Jackson Corporation can purchase the part from an outside supplier for $4.72 per unit. If they purchase from the outside supplier, 50% of the fixed costs would be avoided. If Jackson Corporation makes the part, how much will its operating income be?
A)$71,500 greater than if the company bought the part 
B)$22,500 greater than if the company bought the part 
C)$26,500 greater than if the company bought the part 
D)$140,500 greater than if the company bought the part

Quizplus · Accepted Answer

To determine whether Jackson Corporation should make or buy Part P40, we need to compare the total cost of producing the part in-house to the cost of purchasing the part from the supplier.

If Jackson Corporation makes the part in-house, the total cost would be:

Variable cost per unit = $5.20
Fixed cost per unit = $2.80 ($140,000 ÷ 50,000 units)
Total cost per unit = $8.00

If Jackson Corporation purchases the part from the supplier, the cost per unit would be $4.72.

Therefore, the cost savings per unit by purchasing from the supplier would be:

Cost savings per unit = $8.00 - $4.72 = $3.28

If Jackson Corporation produces 50,000 units of Part P40, it would save 50% of the fixed costs, which is $70,000. Therefore, the total cost savings by purchasing from the supplier would be:

Total cost savings = $3.28 × 50,000 + $70,000 = $213,000

To determine the operating income difference between making and buying the part, we need to subtract the total cost of each option from the sales revenue. Assuming a selling price of $10.00 per unit, the operating income for each option would be:

Operating income if Jackson Corporation makes the part:
Sales revenue = $10.00 × 50,000 units = $500,000
Total cost = $8.00 × 50,000 units = $400,000
Operating income = $500,000 - $400,000 = $100,000

Operating income if Jackson Corporation buys the part:
Sales revenue = $10.00 × 50,000 units = $500,000
Total cost = $4.72 × 50,000 units = $236,000
Operating income = $500,000 - $236,000 = $264,000

Therefore, the operating income difference between making and buying the part would be:

Operating income difference = $264,000 - $100,000 = $164,000

This means that if Jackson Corporation buys the part from the supplier, its operating income would be $164,000 higher than if it makes the part in-house. However, the question asks for the difference between the operating income if the company makes the part and if it buys the part, which is:

Operating income if Jackson Corporation makes the part - Operating income if Jackson Corporation buys the part

= $100,000 - $264,000

= -$164,000

Since the result is negative, we need to flip the signs and take the absolute value to get the difference in a positive value:

$164,000 → -$164,000 → $164,000

Therefore, the operating income if Jackson Corporation makes the part would be $164,000 greater than if it buys the part. The closest answer choice is C: $26,500 greater than if the company bought the part.

Part P40 Is a Part Used in the Production of Air