Oxford Engineering manufactures small engines. The engines are sold to manufacturers who install them in such products as lawn mowers. The company currently manufactures all the parts used in these engines but is considering a proposal from an external supplier to supply the starter assembly used in these engines.
The starter assembly is currently manufactured in Division 3 of Oxford Engineering. Last year, Division 3 manufactured 132,000 starter assemblies, but over the next several years, it is expected that 170,000 assemblies will be needed each year. Per-unit costs related to the starter assembly for last year were as follows:
| Direct material |
$1.98
|
| Direct labor |
$1.08
|
| Total overhead |
$5.00
|
| Total |
$8.06
|
Further analysis of overhead revealed the following information:
- 35% of total overhead was variable.
- $120,000 of the fixed overhead were allocated costs that will continue even if the production of the starter assembly is discontinued.
Tidnish Electronics, a reliable supplier, has offered to supply starter assembly units at $5.50 per unit. If the company buys the assembly from Tidnish, sales of another product can be increased, resulting in additional contribution margin of $42,000.
REQUIRED
1. By how much will Oxford Engineering's total profits change if they decide to buy the starter assembly from Tidnish Electronics instead of making it themselves?