Question

3. Quiett Truck manufactures part WB23 used in several of its truck models. 10,000 units are produced each year with production costs as follows:

              Direct materials                           $ 45,000

              Direct manufacturing labor         15,000

              Variable support costs                  35,000

              Fixed support costs                        25,000

              Total costs                                   $120,000

Quiett Truck has the option of purchasing part WB23 from an outside supplier at $11.20 per unit. If WB23 is outsourced, 40% of the fixed costs cannot be immediately converted to other uses.

a. Describe avoidable costs. What amount of the WB23 production costs is avoidable?

b. Should Quiett Truck outsource WB23? Why or why not?

c. Suppose the space used to produce WB23 can be rented for $4,000. Should Quiett Truck outsource WB23? Why or why not?

d. What other items should Quiett Truck consider before outsourcing any of the parts it currently manufactures?

Answer 1

a. Avoidable costs are those costs eliminated when a part, product, product line, or business segmented is discontinued.

Avoidable production costs for part WB23 total $110,000, which include all of the part's costs except the $10,000 ($25,000 × 40%) of fixed costs that cannot be immediately converted to other uses.

b. Based on the financial considerations given, Quiett Truck should NOT outsource part WB23 because the $112,000 (10,000 units × $11.20 per part) outsourced cost is greater than the $110,000 reduction in annual production costs. In other words, the outsourcing would cost Quiett Truck an additional $2,000 annually.

c. Taking the rent into consideration, Quiett Truck should outsource the production of WB23 parts, as now the $112,000 (10,000 units × $11.20 per part) outsourced cost is less than production and opportunity cost of $114,000. If it outsources, it will earn $2,000 extra.

d. Other factors to consider include the supplier's ability to meet expected quality and delivery standards, and the likelihood of suppliers increasing prices of parts in the future.