Outsourcing (Make-or-Buy) Decision Mountain Air Limited manufactures a line of r

Question

Outsourcing (Make-or-Buy) Decision

Mountain Air Limited manufactures a line of room air purifiers. Management is currently evaluat-

ing the possible production of an air purifier for automobiles. Based on an annual volume of 10,000

units, the predicted cost per unit of an auto air purifier follows.

Direct materials ............................................................ $ 8.00

Direct labor ............................................................... 1.50

Factory overhead .......................................................... 7.00

Total ..................................................................... $16.50

These cost predictions include $50,000 in fixed factory overhead averaged over 10,000 units.

The completed air purifier units include a battery-operated electric motor, which Mountain Air

assembles with parts purchased from an outside vendor for $2.00 per motor. Mini Motor Company

has offered to supply an assembled battery-operated motor at a cost of $5.00 per unit, with a mini-

mum annual order of 5,000 units. If Mountain Air accepts this offer, it will be able to reduce the

variable labor and variable overhead costs of the auto air purifier by 50 percent.

Required

a. Determine whether Mountain Air should continue to make the electric motor or outsource it

from Mini Motor Company. (Hint: analyze the relevant costs of making the “motors,” not the

entire air purifier.)

b. If it could otherwise rent the motor-assembly space for $20,000 per year, should it make or

outsource this component?

c. What additional factors should it consider in deciding whether to make or outsource the elec-

tric motors?

Explanation / Answer

a.   Mountain Air Limited should outsource the electric motor from mini Motor company , it will reduce the cost of making motor from $215000 to $96250

Note:

If Mountain Air Limited does not opt option offered by Mini Motor company:

Direct material ( 10000units * $8) = $80000

Direct labour (10000units * $1.5) = $15000

Factory overehad (10000 units * $7) = $70000

Fixed cost =$50000

Total cost = $ 215000

If Mountain Air Limited opts the option offered by Mini Motor company:

Direct material ( 5000units * $5) = $25000

Direct labour ( 5000units * $ 0.75) = $3750

Factory overehad (5000 units * $3.5) = $17500

Fixed cost =$50000

Total cost = $ 96250

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