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 a supplier in Vietnam to produce 8,900 units per year for $7.50 each. Mohave has the following information about the cost of producing tote bags:        

Direct materials	$	4
Direct labor		1
Variable manufacturing overhead		1
Fixed manufacturing overhead		2.00
Total cost per unit	$	8.00

Mohave has determined that all variable costs could be eliminated by outsourcing 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.

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



2. Should Mohave buy the tote bags or continue to make them?

	Make
	Buy

3-a. 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.

Answer 1

Solution 1:

Differential Analysis- Mohavae Corp. - Making bag (alt 1) or Buying bag (Alt2)
Particulars	Making Bag (Alt 1)	Buying Baf (Alt 2)	Difference in Cost (Alt 2)
Costs:
Purchase Price (8900*$7.50)	$0.00	$66,750.00	-$66,750.00
Direct material	$35,600.00	$0.00	$35,600.00
Direct Labor	$8,900.00	$0.00	$8,900.00
Variable overhead	$8,900.00	$0.00	$8,900.00
Avoidable Fixed Overhead (8,900*2*30%)	$5,340.00	$0.00	$5,340.00
Total Cost	$58,740.00	$66,750.00	-$8,010.00

Solution 2:

As buying cost is higher than making cost, therefore mohave should continue to make tote bags

Solution 3a:

Differential Analysis- Mohavae Corp. - Making bag (alt 1) or Buying bag (Alt2)
Particulars	Making Bag (Alt 1)	Buying Baf (Alt 2)	Difference in Cost (Alt 2)
Costs:
Purchase Price (8900*$7.50)	$0.00	$66,750.00	-$66,750.00
Direct material	$35,600.00	$0.00	$35,600.00
Direct Labor	$8,900.00	$0.00	$8,900.00
Variable overhead	$8,900.00	$0.00	$8,900.00
Avoidable Fixed Overhead (8,900*2*30%)	$5,340.00	$0.00	$5,340.00
Loss of opportunity of new product margin	$12,000.00	$0.00	$12,000.00
Total Cost	$70,740.00	$66,750.00	$3,990.00

Difference in cost between making and buying the umbrella = $3,990