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 9,900 units per year for $10.00 each. Mohave has the following information about the cost of producing tote bags:        

Direct materials	$	6
Direct labor		2
Variable manufacturing overhead		1
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.

1. Compute the difference in cost between making and buying the umbrella tote bag.

Differential Cost of Making Versus Buying

2. 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.

Differential Cost of Making Versus Buying

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

Answer 1

Ans 1
Relevant cost to make
Direct materials	6
Direct labor	2
Variable manufacturing overhead	1
Fixed manufacturing overhead (2*25%)	0.5
Total Relevant cost per unit	9.5
Cost to buy	$10
Differentail cost is $.5 less to make than buy
Ans 2 Should make them
As $.5 is less to make it.
Ans 3
Relevant cost to make	9.5
Cost to buy	9.39
10-(6000/9900)
Differential cost is (9.5-9.39)= $.11 which is more to make
than buy
ans 3 Now Mohave should buy