Question

Dell Inc. makes 1,000 units per year of a part called Optical Drives for use in one of its products. Data concerning the unit production costs of the optical drives follow:

Direct materials	$342
Direct labour	80
Variable manufacturing overhead	48
Fixed manufacturing overhead	520
Total manufacturing cost per unit	$990

An outside supplier has offered to sell Dell Inc. all of the optical drives it requires. If Dell decided to discontinue making the optical drives, 10% of the above fixed manufacturing overhead costs could be avoided.

Required:

i. Assume Dell has no alternative use for the facilities presently devoted to the production of the optical drives. If the outside supplier offers to sell the optical drives for $850 each, should Dell accept the offer? Fully support your answer with appropriate calculations.      

ii. Assume that Dell could use the facilities presently devoted to the production of the optical drives to expand production of another product that would yield an additional contribution margin of $50,000 annually. What is the maximum price Dell should be willing to pay the outside supplier for each unit optical drives? Show your calculations.

iii. With reference to (i) and (ii), discuss four other factors that managers need to consider in order to make a more informed decision about whether to buy the part from the outside suppliers or not. [Maximum word limit: 120 words].

Answer 1

If Dell purchase the optical driver

Purchase cost =$850

If Dell makes optical driver

Material Cost. 342

Labour cost. 80

V.ohd. 48

Avoidable Fixed Ohd. 52

(10%*520)

Total cost. $ 522

Since the cost of making optical driver is less than purchase price Dell should make the component rather than buying.

Part 2

Maximum price = Manufacturing cost + contribution lost

=522+50000/1000

= 522+50

=572

Part 3

1) Quality - Before Buying the product from outside Dell must ensure component supplied is of good quality.

2) Timely Delivery - Dell must ensure that components are delivered timely by the supplier.

3) Inspection- Dell