7. Watson Wheels currently makes 6,000 wheels annually that are used in other products it manufactures. Current unit costs for the wheels are as follows: Direct materials $22.00 Direct labor 16.00 Variable manufacturing overhead 12.00 Fixed manufacturing overhead 15.00 Total $65.00 The company has an offer from a manufacturer to produce the wheels for $60 per wheel. If the company decides to buy the wheels, the empty warehouse space could be rented for $22,000 annually. In addition, half of the fixed manufacturing overhead costs would be avoided if the company decides to buy the wheels. If the company decides to accept the offer, what is the incremental effect on the company's net income?

It is more convenient to buy the units. Income will increase by $7,000.

Explanation:

Giving the following information:

Units = 6,000

Current unit costs for the wheels are as follows:

Direct materials $22.00

Direct labor 16.00

Variable manufacturing overhead 12.00

Avoidable fixed manufacturing overhead = 7.5

The company has an offer from a manufacturer to produce the wheels for $60 per wheel.

If the company decides to buy the wheels, the empty warehouse space could be rented for $22,000 annually.

First, we need to calculate the differential cost of making the units:

Total cost = 6,000 * (22 + 16 + 12 + 7.5) = $345,000

Now, buying the units:

Total cost = 6,000*60 - 22,000 = $338,000

It is more convenient to buy the units. Income will increase by $7,000.