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 $8.00 Direct labor 1.50 Factory overhead 7.00 Total $16.50 These cost predictions include $40,000 in facility-level fixed factory overhead averaged over 10,000 units. One of the component parts of the auto air purifier is a battery-operated electric motor. Although the company does not currently manufacture these motors, the preceding cost predictions are based on the assumption that it will assemble such a motor. Mini Motor Company has offered to supply an assembled battery-operated motor at a cost of $4.50 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. The electric motor's components will cost $1.00 if Mountain Air assembles the motors. (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 $28,000 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) Management should consider which of the following nonquantitative factors in deciding whether to make or buy the 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.

Answer 1

Solution a:

Factory overhead per unit of producing air purifier for automobiles = $7 per unit

Fixed factory overhead cost per unit = $40,000 /10000 = $ 4 per unit

Variable factory overhead per unit = $7 - $4 = $3 per unit

Differential Analysis - Making electric motors (alt 1) or Buying electric motors (Alt2) - Mountain Air Ltd
Particulars	Making electric motors (Alt 1)	Buying electric motors (Alt 2)	Financial advantage (Disadvantage) of buying (Alternative 2)
Relevant Costs:
Purchase Price (10000*$4.50)	$0.00	$45,000.00	-$45,000.00
Direct material (10000*$1)	$10,000.00	$0.00	$10,000.00
Direct Labor (10000*$0.75)	$7,500.00	$0.00	$7,500.00
Variable overhead (10000 *$1.50)	$15,000.00	$0.00	$15,000.00
Total Cost	$32,500.00	$45,000.00	-$12,500.00

Net advantage (disadvantage) of outsourcing the electric motors from Mini Motor Company = ($12,500)

Solution b:

Differential Analysis - Making electric motors (alt 1) or Buying electric motors (Alt2) - Mountain Air Ltd
Particulars	Making electric motors (Alt 1)	Buying electric motors (Alt 2)	Financial advantage (Disadvantage) of buying (Alternative 2)
Relevant Costs:
Purchase Price (10000*$4.50)	$0.00	$45,000.00	-$45,000.00
Direct material (10000*$1)	$10,000.00	$0.00	$10,000.00
Direct Labor (10000*$0.75)	$7,500.00	$0.00	$7,500.00
Variable overhead (10000 *$1.50)	$15,000.00	$0.00	$15,000.00
Opportunity cost to rent motor assembly space	$28,000.00	$0.00	$28,000.00
Total Cost	$60,500.00	$45,000.00	$15,500.00

Net advantage (disadvantage) of outsourcing the motors = $15,500

Solution c:

Managemnet should consider all of these non qualitative factors in deciding whether to make or buy the motors:

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

2. The dependability of the supplier

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

4. Whether they can depend on Mini Motor to supply motors for a number of years

5. whether it is attempting to use some temporarily idle capacity