Mohave Corp. is considering outsourcing production of the umbrella tote bag incl

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 Willow Co. to produce 8,900 units per year for $7.5 each. Mohave has the following information about its own production of the tote bags:

        

   

Mohave has determined that all variable costs could be eliminated by dropping production of the tote bags, while 70 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.

   

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

   

   

Suppose that the space Mohave currently uses to make the bags could be utilized by a new product line that would generate $12,000 in annual profits. Recompute the difference in cost between making and buying the umbrella tote bag.

Mohave Corp. is considering outsourcing production of the umbrella tote bag included with some of its products. The company has received a bid from Willow Co. to produce 8,900 units per year for $7.5 each. Mohave has the following information about its own production of the tote bags:

Differential Cost of Making Versus Buying

Explanation / Answer

Part 1)

The differential cost is calculated with the use of following table:

Differential Cost of Making Versus Buying = $8,010 (66,750 - 58,740)

Notes:

1) We will consider only the relevant portion of fixed cost (30%) which can be avoided if the company decided to buy the product from outside supplier.

_________

Part 2)

The company should Continue to Make the Product as it results in lower cost.

_________

Part 3-a)

The revised differential cost is calculated with the use of following table:

Differential Cost of Making Versus Buying = $3,990 (70,740 - 66,750)

_________

Part 3-b)

Yes, the company should "Buy the Product" from outside as it results in lower cost.

Differential Costs 8,900 units Make Buy Make Buy Cost of Purchasing 7.5 66,750 (8,900*7.50) Cost of Making Direct Materials 4 0 35,600 (8,900*4) Direct Labor 1 0 8,900 (8,900*1) Variable Manufacturing Overhead 1 0 8,900 (8,900*1) Fixed Manufacturing Overhead (2*30%) 0.6 0 5,340 (8,900.60) Total Cost $6.6 $7.5 $58,740 $66,750

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