Question

Barber Manufacturing currently makes 2,000 units of gas-powered leaf blowers each year. However, the company has found a manufacturing company that can provide the blowers at a price of $14 each. The company is considering purchasing the blowers. If the company purchases the blower, the machine can be used to produce 5,000 units of another product that would generate a contribution of $2 per unit. There will be no need of supervisor if Barber goes for outsourcing. Barber’s standard cost for a blower is listed below.

Direct Material…………………………………………………….….. $4

Direct labor…………………………………………………………..… 2

Variable cost…………………………………………………………… 3

Fixed Cost

Depreciation …………………………………………..…………….…..3

CEO’s Salary……………………………………………………………2

Supervisor’s salary (directly connected with blower) ………………..4                   

Cost per unit                                                                           $18

Required:

1. Should Barber purchase the blower outside or make it at his own.
2. List five ways that management can seek to relax a constraint by expanding the capacity of a bottleneck operation.

Answer 1

a. Barbers should purchase the blowers, as that would result in a $ 8,000 increase in net operating income.

	Make	Buy	Increase ( decrease) in Operating Income
Direct materials ( 2,000 units x $ 4)	$ 8,000	$ 0	$ 8,000
Direct labor ( 2,000 units x $ 2)	4,000	0	4,000
Variable cost ( 2,000 units x $ 3)	6,000	0	6,000
Supervisor's salary ( 2,000 units x $ 4)	8,000	0	8,000
Opportunity cost ( 5,000 units x $ 2)	10,000	0	10,000
Cost of purchase from outside supplier	0	28,000	(28,000)
Totals	$36,000	$28,000	$ 8,000

Depreciation is a sunk cost, therefore it is not relevant.

CEO's salary would be incurred irrespective of whether the blowers are made inhouse or outsourced. Therefore, this cost too is not relevant for decision making.

b. Five ways that management can seek to relax a constraint by expanding the capacity of a bottleneck operation:

1. Reduction of downtime.
2. Addition of resources to the bottleneck operation.
3. The constrained resource should not be wasted on bad parts. If quality checks are required, they should be ddone before the bottleneck operation.
4. Analyse the production schedule to create a product mix that reduces the overall demand on the bottleneck, at the same time increasing profitability by prioritising products with higher contribution margin per unit of bottleneck.
5. Reassignment of some of the bottleck operations results in shorter cycle time and increased capacity.