Question

Morning Sky, Inc. (MSI), manufactures and sells computer games. The company has several product lines based on the age range of the target market. MSI sells both individual games as well as packaged sets. All games are in CD format, and some utilize accessories such as steering wheels, electronic tablets, and hand controls. To date, MSI has developed and manufactured all the CDs itself as well as the accessories and packaging for all of its products.

The gaming market has traditionally been targeted at teenagers and young adults; however, the increasing affordability of computers and the incorporation of computer activities into junior high and elementary school curriculums has led to a significant increase in sales to younger children. MSI has always included games for younger children but now wants to expand its business to capitalize on changes in the industry. The company currently has excess capacity and is investigating several possible ways to improve profitability.

MSI is considering outsourcing the production of the handheld control module used with some of its products. The company has received a bid from Monte Legend Co. (MLC) to produce 18,000 units of the module per year for $25.00 each. The following information pertains to MSI’s production of the control modules:        

Direct materials	$	10
Direct labor		7
Variable manufacturing overhead		7
Fixed manufacturing overhead		4
Total cost per unit	$	28

MSI has determined that it could eliminate all variable costs if the control modules were produced externally, but none of the fixed overhead is avoidable. At this time, MSI has no specific use in mind for the space that is currently dedicated to the control module production.

Required:
1. Compute the difference in cost between making and buying the control module.

2. Should MSI buy the modules from MLC or continue to make them?

3-a. Suppose that the MSI space currently used for the modules could be utilized by a new product line that would generate $28,000 in annual profit. Recompute the difference in cost between making and buying under this scenario.

3-b. Does this change your recommendation to MSI?

Answer 1

1) Calculate different in cost :

	Make	Buy
Direct material	18000*10 = 180000
Direct labour	18000*7 = 126000
Variable manufacturing overhead	18000*7 = 126000
Fixed manufacturing overhead	18000*4 = 72000	72000
Purchase cost		18000*25 = 450000
Total relevant cost	504000	522000

Difference in cost = 504000-522000 = 18000

2) Continue to make

3) Calculate different in cost :

	Make	Buy
Direct material	18000*10 = 180000
Direct labour	18000*7 = 126000
Variable manufacturing overhead	18000*7 = 126000
Fixed manufacturing overhead	18000*4 = 72000	72000
Opportunity Cost	28000
Purchase cost		18000*25 = 450000
Total relevant cost	532000	522000

Difference in cost = 532000-522000 = 10000

3b) Yes, Company should buy