Question

Sunshine Ltd manufactures motorised skateboards. Currently, the company produces 5,000 units. Sunshine Ltd makes the motor for their motorised scooter range in batches of 500 units (i.e. 10 batches for 5,000 units). The equipment used to make the motors is rented from Scania Engineering. Inspection, set‐up and materials‐handling costs vary with the number of batches. The costs for making 5000 motors are as follows:

	Cost/unit	Cost for 5,000 units
Direct materials	$      4.00	$                    20,000
Direct labour	$      2.00	$                    10,000
Variable manufacturing overhead (utilities)	$      1.50	$                      7,500
Inspection, set‐up, materials handling		$                      1,000
Equipment rental		$                      1,500
Allocated fixed costs of manufacturing overhead		$                    15,000
Total costs		$                   55,000

Scania Engineering is offering to supply the motors required by Sunshine Ltd at $8.20 each. Deciding to take up the Scania Engineering offer will mean that Sunshine Ltd has no need to rent the equipment.

Required (show your workings):

If Sunshine Ltd accept the offer from Scania Engineering, the facility where the motors are currently manufactured will be idle. At the expected production and sales volume of 5,000 units, calculate the total relevant costs of buying the motor from Scania Engineering. On the basis of financial considerations alone, should the offer from Scania Engineering be accepted?

If Sunshine Ltd accepts the offer from Scania Engineering, the facility where the motors are currently manufactured will be used to add a light and horn to the motorised scooters. This upgrade means that the motorised scooters can be sold for an additional $20 premium. The variable cost per unit of the light and horn upgrade would be $18 and additional fixed costs of $8,000 would be incurred. On the basis of financial considerations alone, should Sunshine Ltd make or buy the motors, assuming that 5,000 units are produced (and sold)? Show your calculations.

What other factors (qualitative) should Sunshine Ltd consider when making this decision?

Answer 1

	a)	Incremental cost analysis
			If motor is produced	if motor is purchased	Increase (decrease) in profits
		Direct Materials	$20,000		$20,000
		Direct Labor	$10,000		$10,000
		Variable Manufacturing overhead	$7,500		$7,500
		Purchases of Motor (5000*8.20)		41000	-41000
		Savings on Equipment rental			($1,500)
		Decrease in profits			($5,000)
		Since the cost of purchasing the motors is more as compared to manufacturing Sunshine Ltd should manufacture the motors
	b)		If motor is produced	if motor is purchased	Increase (decrease) in profits
		Direct Materials	$20,000		$20,000
		Direct Labor	$10,000		$10,000
		Variable Manufacturing overhead	$7,500		$7,500
		Purchases of Motor (5000*8.20)		41000	-41000
		Savings on Equipment rental			($1,500)
		Increase in Sales		100000	100000
		Variable cost for upgrade		90000	-90000
		Additional Fixed Costs		8000	-8000
		Decrease in profits			($3,000)
		Since the above offer leads to decrease in profits, the company should manufacture the motors
	c	Sunshine should consider the demand outside for the upgraded version, if there is any other supplier who can provide the motors at cheaper rate than Scania Engineering