Question

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 9,800 units per year for $9.00 each. Mohave has the following information about the cost of producing tote bags:

Direct materials	5.00
Direct labor	2.00
Variable manufacturing overhead	1.00
Fixed manufacturing overhead	2.00
Total cost per unit	10.00

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?

Answer 1

1
	Per unit		Total 9800 units
	Make	Buy	Make	Buy
Direct materials	5.00		49000
Direct labor	2.00		19600
Variable manufacturing overhead	1.00		9800
Fixed manufacturing overhead avoidable	0.50		4900
Purchase cost		9.00		88200
Total			83300	88200
Difference in cost = $4900 (83300-88200)
2
Make, as cost is less
3a
	Make	Buy
Total cost	83300	88200
Opportunity cost	6000
Total relevant cost	89300	88200
Difference in cost = $1100 (89300-88200)
3b
Yes, now the recommendation is Buy