Zion Manufacturing had always made its components in-house. However, Bryce Component Works had recently offered to supply one component, K2, at a price of $25 each. Zion uses 10,000 units of Component K2 each year. The cost per unit of this component is as follows:
Direct materials ......................$12.00
Direct labor ........................... 8.25
Variable overhead ................... 3.50
Fixed overhead ....................... 2.00
Total ....................................$25.75
Assume that 75 percent of Zion Manufacturing's fixed overhead for Component K2 would be eliminated if that component were no longer produced.
Required:
If Zion decides to purchase the component from Bryce, by how much will operating income increase or decrease? Which alternative is better?