Question

Outsourcing (Make-or-Buy) Decision
Mountain Air Limited manufactures a line of room air purifiers. Management is currently evaluating 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	$ 9.00
Direct labor	1.40
Factory overhead	10.00
Total	$ 20.40

These cost predictions include $80,000 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 $5.50 per unit, with a minimum 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.

(a) Determine whether Mountain Air should continue to make the electric motor or outsource it from Mini Motor Company.

• Calculate the net advantage (disadvantage) of outsourcing the electric motors from Mini Motor Company.

• Use a negative sign with your answer to indicate a net disadvantage (if applicable.)
  $Answer

(b) If it could otherwise rent the motor-assembly space for $25,000 per year, should it make or outsource this component?

• Calculate the net advantage (disadvantage) of outsourcing the motors, assuming the space could be rented.
• Use a negative sign with your answer to indicate a net disadvantage (if applicable).
  $Answer

(c) What additional factors should it consider in deciding whether to make or outsource the electric motors?

The quality of their own and the supplier's motors.

The dependability of the supplier.

Whether Mini Motor has a track record of meeting its commitments.

Whether they can depend on Mini Motor to supply motors for a number of years or whether it is attempting to use some temporarily idle capacity.

All of these.

Please answer all questions. Thank you.

Answer 1

50% reduction in the variable labor and variable overhead costs of the auto air purifier:

New variable labor cost = 1.40 x (1 - 50%) = 0.70

Total overhead = 10 x 10,000 = 100,000 = Fixed overhead + variable overhead = 80,000 + Variable overhead per unit x 10,000

Hence, old variable overhead per unit = (100,000 - 80,000) / 10,000 = 2

New variable overhead per unit = 2 x (1 - 50%) = 1

Part (a)

Please see the table below. Blue colored cells are where changes due to 50% reduction have been reflected. Net advantage / disadvantage on outsourcing = $ (18,000) [Please note it's a negative value, implying disadvantage). Hence, Mountain Air should continue to make the electric motor .

	Make		Buy		Net Advantage / (Disadvantage)
	Per unit	Total cost	Per unit	Total cost
Direct materials	9.00	90,000	9.00	90,000	-
Direct labor	1.40	14,000	0.70	7,000	7,000
Variable factory overhead ($10 - $8)	2.00	20,000	1.00	10,000	10,000
Fixed factory overhead ($80000/10000 units)	8.00	80,000	8.00	80,000	-
Electric motor	2.00	20,000	5.50	55,000	(35,000)
Net advantage / (disadvantage)	22.40	224,000	24.20	242,000	(18,000)

Part (b)

If it could otherwise rent the motor-assembly space for $25,000 per year, the net advantage of outsourcing turns out to be $ 7,000. Hence, it should outsource this component.

Please see the table below:

	Make		Buy		Net Advantage / (Disadvantage)
	Per unit	Total cost	Per unit	Total cost
Direct materials	9.00	90,000	9.00	90,000	-
Direct labor	1.40	14,000	0.70	7,000	7,000
Variable factory overhead ($10 - $8)	2.00	20,000	1.00	10,000	10,000
Fixed factory overhead ($80000/10000 units)	8.00	80,000	8.00	80,000	-
Electric motor	2.00	20,000	5.50	55,000	(35,000)
Opportunity cost of renting		25,000			25,000
Net advantage / (disadvantage)	22.40	249,000	24.20	242,000	7,000

Part (c)

Please choose the last option stating "All of these".

All these factors are important consideration to ponder about.