Question

MSI is considering outsourcing the production of the handheld control module used with some of its products. The company has received a bid from Monte Legend Co. (MLC) to produce 15,000 units of the module per year for $32.00 each. The following information pertains to MSI’s production of the control modules:

Direct materials	$	15
Direct labor		10
Variable manufacturing overhead		6
Fixed manufacturing overhead		3
Total cost per unit	$	34

MSI has determined that it could eliminate all variable costs if the control modules were produced externally, but none of the fixed overhead is avoidable. At this time, MSI has no specific use in mind for the space that is currently dedicated to the control module production.

Required:
1. Compute the difference in cost between making and buying the control module.

2. Should MSI buy the modules from MLC or continue to make them?

3-a. Suppose that the MSI space currently used for the modules could be utilized by a new product line that would generate $27,000 in annual profit. Recompute the difference in cost between making and buying under this scenario.

3-b. Does this change your recommendation to MSI?

Answer 1

Ans:

1.

Cost of Buying:

Units bought: 15,000

Cost per unit: $32

Cost of buying = 15,000*32 = $480,000

Unavoidable fixed cost = 15,000 * $3 per unit = $45,000

Total cost in buying = $480,000+$45,000 = $525,000

Cost of making:

Variable cost per unit:

Direct material: $15

Direct Labour ; $10

Variable over head : $6

Total variable cost per unit = $15+$10+$6 = $31

Fixed cost per unit = $3

Total cost per Unit = $31+$3 = $34

Cost of making 15,000 units = $15,000*$34 = $510,000

2.

As cost of making is less than cost of buying MSI should continue to make.

3.

In case MSI used the space to earn $27,000 if they buy modules from MLC.

Cost of buying:

Cost of Buying:

Units bought: 15,000

Cost per unit: $32

Cost of buying = 15,000*32 = $480,000

Unavoidable fixed cost = 15,000 * $3 per unit = $45,000

Profit earned from space utilisation = ($27,000)

Total cost in buying = $480,000+$45,000-$27,000 = $508,000

Cost of making 15,000 units = $15,000*$34 = $510,000

4.

In such case MSI should buy the modules from MLC and utilise the vacant space to earn $27,000.

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