Spikes Company manufactures 5,000 high-end racing bicycles each period. Spikes has been making all the components for the bikes, but a supplier has approached Spikes with an offer to sell her bicycle seats at a price of $40. The cost per unit of manufacturing one bicycle seat is computed as ollows: $10 $18 Direct Material Direct Labor Manufacturing overhead (100% fixed) $10 If the bicycle seats are purchased from the outside supplier, $1 per unit of the fixed manufacturing overhead costs can be avoided. If Spikes purchases the seats, the facility used to manufacture the seats would be rented for $20,000 per period. If Spikes chooses to purchase the bicycle seats, the the change in annual net operating income is an: A. $35,000 decrease. B. $35,000 increase. C. $5,000 decrease. D. $5,000 increase. E. $10,000 increase.

A

Explanation:

Option A Manufactures Bicycles

Costs

$10*5000=-$50000

$18*5000=-$90000

$10*5000=-$5000

total cost =$-190000

Purchase the bicycles seats

$40*5000=-$200000

$9*5000= -$45000

$20000 from rent facility

total costs =-225 000

Costs has increased meaning for same sales the profits will decrease by $35 000 .

$190000-$225000=$35000

A. $ 35,000 decrease

Explanation:

Computation of effect on net income

Cost of seat procured from outside $ 40 per seat

No of units manufactured                 5000 units

Total cost of purchase ( 5000 units * $ 40)                               $ 200,000

Savings in internal cost if procured from outside

Direct Materials $ 10 per seat * 5,000                    $ 50,000

Direct Labour  $ 18 per seat * 5,000                       $ 90,000

Differential in Fixed manufacturing overhead $ 1  $    5,000

Rental revenue from space                                     $ 20,000

Total impact on income from procurement                                $ 165,000

Incremental cost of procuring from  outside                             $  35,000

Since outside procurememt shall entail an additional cost of $ 35,000. the net income shall decrease by $ 35,000