Your company is launching a new product. Currently you have the capability to ma

Question

Your company is launching a new product. Currently you have the capability to manufacture everything in your plant with the exception of one key component. As the plant manager, senior management is relying on you to determine if this component should be outsourced or manufactured in your plant. Below are the costs associated with each option:

To manufacture the product:

- Fixed costs would increase by $250,000

- The variable cost to manufacture this component is $20 each

To outsource the product:

- You have found a supplier that will sell you the component for $24 each

- The cost to ship the component from the supplier to your plant is $1 per piece

a. What recommendation would you make to senior management? (show the math)

b. Fully explain your rationale?

Explanation / Answer

Option 1 Option 2 Manufacture Product Outsource Fixed Cost $250,000 $0 Variable Cost $20 $25 ($24 + $1 = Cost + Shipping) Calculation of Effective Range for Output Indifference Point = Change in Fixed Cost / Change in Variable Cost = 250000 / (25 - 20) = 50000 units So upto 49,999 units Outsourcing is cheaper, 50000 units is point of indifference and from 50001 units, it is cheaper to manufacture. The rationale in simple - The cost of manufacturing is cheaper to the tune of $5 per unit but manufacturing involves an additional fixed cost of $250,0000 To ensure that manufacturing is the cheaper option, fixed costs need to be recovered from the savings due to difference in variable costs. Once the, fixed costs are recovered, Manufacturing process would be cheaper

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