Question

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 9,000 units of the module per year for $20.00 each. The following information pertains to MSI’s production of the control modules: Direct materials $ 9 Direct labor 6 Variable manufacturing overhead 3 Fixed manufacturing overhead 6 Total cost per unit $ 24 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? Buy Make 3-a. Suppose that the MSI space currently used for the modules could be utilized by a new product line that would generate $25,000 in annual profit. Recompute the difference in cost between making and buying under this scenario. 3-b. Does this change your recommendation to MSI? Yes No

Answer 1

1) Differential analysis :

	Make	Buy
Direct material	9000*9 = 81000
Direct labour	9000*6 = 54000
Variable overhead	27000
Purchase		180000
Total relevant cost	162000	180000

Difference in Cost = (180000-162000) = $18000

2) Continue to make

3) Differential analysis :

	Make	Buy
Direct material	9000*9 = 81000
Direct labour	9000*6 = 54000
Variable overhead	27000
Contribution margin	25000
Purchase		180000
Total relevant cost	187000	180000

Difference in Cost = (180000-187000) = $7000

3b) Yes, Now MSI should buy