Shaw Enterprises manufactures one of the components used to assemble its main company product. Specialty Products, Inc., has offered to make the component at a cost of $12.80 per unit. Shaw Enterprises’ current cost is $14.75 per unit of the component, based on the 100,000 components that Shaw Enterprises currently produces. This current cost per unit is based on the following calculations:

Direct material per unit ……………………………………………………………………… $ 5.00

Direct labor per unit …………………………………………………………………………….. 6.00

Variable manufacturing overhead per unit ……………………………………………… 1.75

Fixed manufacturing overhead per unit ………………………………………………….. 2.00

Total manufacturing costs per unit ……………………………………………………. $ 14.75

None of Shaw Enterprises’ fixed costs will be eliminated if the component is outsourced. However, the freed capacity could be used to build a new product. This new product would be expected to generate $30,000 of contribution margin per year.

Requirements

1. If Shaw Enterprises outsources the manufacturing of the component, will operating income increase or decrease? By how much?

2. What is the maximum price per unit Shaw Enterprises would be willing to pay if it outsources the component?



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