Question

Outsourcing (Make-or-Buy) Decision
Coway manufactures a line of room air purifiers. Assume that management is currently evaluating the possible production of an air purifier for automobiles. Based on an annual volume of 50,000 units, the predicted cost per unit of an auto air purifier follows.

Direct materials	$ 2.50
Direct labor	2.00
Factory overhead	12.00
Total	$ 16.50

These cost predictions include $450,000 in fixed factory overhead averaged over 50,000 units.

The completed air purifier units include a battery-operated electric motor, which Coway assembles with parts purchased from an outside vendor for $2.00 per motor. Mini Motor Company has offered to supply an assembled battery-operated motor at a cost of $5.25 per unit, with a minimum annual order of 5,000 units. If Coway accepts this offer, it will be able to reduce the variable labor and variable overhead costs of the auto air purifier by 50 percent.

(a) Determine whether Coway should continue to make the electric motor or outsource it from Mini Motor Company. (Hint: Analyze the relevant costs of making the “motors,” not the entire air purifier.)

• 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 of outsourcing (if applicable.)
  $Answer

(b) If it could otherwise rent the motor-assembly space for $50,000 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 of outsourcing (if applicable).

Answer 1

	Calculation of Net advantage/ disadvantage of outsourcing from mini motors	$	$
A	Cost if purchased from Mini motor		5.25
	Less: Savings in Cost if outsourced
	Cost of the part purchased from an outside vendor	2.00
	Reduction in variable labor costs ($2 x 50%)	1.00
	Reduction in variable overhead costs ($3 x 50%) see below	1.50
	Total savings in cost		4.50
	Disadvantage per unit if purchased from Mini motor ($5.25- $4.50)		-0.75
	Net disadvantage of outsourcing from mini motors for 50000 units (-0.75 x 50,000)		-37500.00
	Suggestion: Coway should continue to make the electric motor because if it is purchased from Mini Motors it would be at a disadvantage of -$37,500.
	Calculation of variable overhead cost per unit
	Total Factory Overhead = 50,000 units x $12 per unit= $600,000
	Fixed Overhead = $450,000
	Variable overhead = $600,000 - $450,000 = $150,000
	Variable overhead per unit = $150,000 / 50,000 units = $3 per unit

B	If the assembly space is rented $50,000 per year,
	Net advantage would be = Net disadvantage in outsourcing from Mini Motors + Income from renting the assembly space = -$37,500 +$50,000 = $12,500
	Suggestion: Coway should outsourse the component to Mini motors, if the assembly space is rented for $50,000 per year, as it would result in a net advantage of $12,500.