Mohave Corp. is considering outsourcing production of the umbrella tote bag included with some of its products. The company has received a bid from a supplier in Vietnam to produce 9,900 units per year for $10.00 each. Mohave has the following information about the cost of producing tote bags:
Direct materials | $6.00 |
Direct Labor | 2.00 |
Variable manufacturing overhead | 1.00 |
Fixed manufacturing overhead | 2.00 |
Total cost per unit | 11.00 |
Mohave has determined that all variable costs could be
eliminated by outsourcing the tote bags, while 75 percent of the
fixed overhead cost is unavoidable. At this time, Mohave has no
specific use in mind for the space currently dedicated to producing
the tote bags.
Required:
1. Compute the difference in cost between making and
buying the umbrella tote bag.
2. Based strictly on the incremental analysis,
should Mohave buy the tote bags or continue to make them?
3-a. Suppose that the space Mohave currently uses
to make the bags could be utilized by a new product line that would
generate $6,000 in annual profits. Recompute the difference in cost
between making and buying the umbrella tote bag.
3-b. Does this change your recommendation to
Mohave?
1. Differential cost of making versus buying
__________ | Favors Buying vs Favors Making |
2. Should Mohave buy the tote bags or continue to make them?
Make
Buy
3. Suppose that the space Mohave currently uses to make the bags could be utilized by a new product line that would generate $6,000 in annual profits. Recompute the difference in cost between making and buying the umbrella tote bag.
Differential Cost of Making Versus Buying
___________ |
Favors buying vs favors making |
4. Does this change your recommendation to Mohave?
Yes or No
we will consider only 25% avoidable fixed OH . As 75% would remain same in both the situation (Make/Buy) it is not relevant.
Make | Buy | ||||
Direct Material | $59,400[$6*9,900] | ||||
Direct labor | $19,800[$2*9,900] | ||||
Variable OH | $9,900[$1*9,900] | ||||
Fixed OH | $4,950[$2*9,900]*25% | ||||
cost of buying | $99,000[9,900*$10] | ||||
Total cost | $94,050 | $99,000 | |||
2) company should make the bag as its cost is lesser than cost of buying by $4,950[$99,000-94,050]
3)
Make | Buy | |
Manufacturing cost | $94,050 | |
Purchase cost | $99,000 | |
Opportunity cost of not making new product line bags | $6,000 | |
Total cost | $100,050 | $99,000 |
4) In this case cost of buying is lesser so it should be bought from outside.
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